POLITICAL ECONOMY OF TRADE POLICY Jacob A. Jordaan Utrecht University School of Economics j.a.jordaan@uu.nl Outline • Introduction • Economic self-interest approach • Social concerns approach • Median voter model • Lobbying • Empirical paper: can we explain politician’s voting behaviour? • Discussion Lecture 8 Political Economy of Trade Policy 2 Literature • Baldwin, R.E. (1989) The political economy of trade policy. The Journal of Economic Perspectives, vol. 3.4, p. 119-135 • Markusen, J.R., Melvin, J.R, Kaempfer, W.H. and Maskus, K.E. (1995) The political economy of trade policy. Chapter 8 in: International trade: Theory and evidence. McGraw-Hill, p. 324- 340 • Owen, E. (2017) Exposure to offshoring and the politics of trade liberalization: Debate and votes on free trade agreements in the US House of Representatives, 2001-2006. International Studies Quarterly, vol. 61, p. 297-311 Lecture 8 Political Economy of Trade Policy 3 Introduction • Economic theory: Trade is good for welfare • Reality: countries are engaged in all sorts of trade policies and international negotiations • This is actually difficult for economists to explain • Politicians don’t know what they are doing • Politicians follow public opinion • Political economy of trade policy Lecture 8 Political Economy of Trade Policy 4 Trade policy “International trade is a subject where the advice of economists is routinely disgarded” (Baldwin, 1989) “The compelling case for free trade carries hardly any weight among people who really matter” (Krugman, 1997) Markusen (chapter) “The analysis developed in this chapter may lead students to wonder why we do not see an even more pervasive use of trade policy” Lecture 8 Political Economy of Trade Policy 5 Lecture 8 Political Economy of Trade Policy 6 Political economy of trade policy • Large differences between theories of free trade and actions of politicians • Public choice economics • Study of governmental decision making behaviour using economic models • Indirect: factors influencing voting behaviour of politicans • Two main sets of factors • Economic self interest approach • Social concerns approach Lecture 8 Political Economy of Trade Policy 7 Economic self interest approach • Personal gains/losses decide whether trade policy is supported or not • Under costless redistribution and voting • Free trade selected • But free trade often not selected • Costs of redistribution and voting (+ decreasing gains) • Free rider problem • Common interest groups • Psychology: greater weight attached to loss than to gain of similar size • “Don’t buy foreign” Lecture 8 Political Economy of Trade Policy 8 New trend in the US Lecture 8 Political Economy of Trade Policy 9 Reasons to buy american products • The job creation equation • American manufacturing = more jobs • Recycling dollars • Keeping America beautiful • Environmental conservation • Human rights • Democracy • Foreign outsource elimination • Poverty • Financial growth http://www.madeintheusa.com/blog/2014/03/10-reasons-buy- american/ Lecture 8 Political Economy of Trade Policy 10 Social concerns approach • Trade policies • Concern for welfare of certain groups in society • To promote national and international goals • (Trade policy reflects political ideology?) • Concerns for groups in society • Conservative welfare function • Income distribution goals • Trade policy is redistributive in nature • But are trade policies the best option here? • First and second best policies Lecture 8 Political Economy of Trade Policy 11 Lecture 8 Political Economy of Trade Policy 12 Chapter by Markusen • Public choice economics • Study of governmental decision making behaviour using economic models • Decision maker & utility maximizer • Key assumption: politician wants to be re-elected • Median voter model very useful • Why relevant for trade policies? • Trade policies have redistributive effects • (Capital versus labour, high versus low-skilled labour) • (Import-competing versus exporting industries) Lecture 8 Political Economy of Trade Policy 13 Median voter model Lecture 8 Political Economy of Trade Policy 14 Decision making problems (1) No incorporation of intensity of preferences Lecture 8 Political Economy of Trade Policy 15 0.4 Gains > 0.6 Losses But politician will reject policy Logrolling • Way for minority groups / special interest groups to get the policy that they want Lecture 8 Political Economy of Trade Policy 16 A and B give 5 to C to compensate, A and B gain Smoot-Hawley tariff 1930 Lecture 8 Political Economy of Trade Policy 17 Congressman Willis Hawley, Oregon Senator Reed Smoot, Utah The Economist, Dec 18th 2008 Lecture 8 Political Economy of Trade Policy 18 Background and log rolling • 1920s several attempts to help agriculture sector • President Coolidge vetoed these attempts • 1928 Democratic president Hoover took office • Promised to help the sector • Hawley chairman of the House Ways and Means Committee • All kinds of meetings, much broader than agriculture sector • House bill raised 845 tariff rates, on manufacturing and agricultural activities Lecture 8 Political Economy of Trade Policy 19 Further log rolling • Bill to the Senate • Smoot chairman of the Finance Committee • Senators who thought that their constituents lost out in the Bill started asking for increased tariffs as well • Discussion changed • From agriculture versus industries to • Classic vote-trading among unrelated goods • Senate’s bill contained 1,253 changes • Compromise: 890 tariffs increased, 235 tariffs cut • Led to strong worsening of trade relations with other countries Lecture 8 Political Economy of Trade Policy 20 Decision making problems (2) • Rational ignorance and abstention (no voting) • Free rider problem Lecture 8 Political Economy of Trade Policy 21 A B A > B Decision making problems (3) • Interest groups / lobbies Lecture 8 Political Economy of Trade Policy 22 A B A > B Why do we have lobbies? • Solve free rider problem for interest groups • Funding for politicians • Rent seeking • Solve for incomplete information Lecture 8 Political Economy of Trade Policy 23 Interesting website • Corporate Europe Observatory • “Exposing the power of corporate lobbying in the EU” • https://corporateeurope.org/ • https://corporateeurope.org/researching-corporate- lobbying-eu • In the US lobbying has been a commonly accepted process • At EU level, this is rapidly developing Lecture 8 Political Economy of Trade Policy 24 Number of lobby organisations Lecture 8 Political Economy of Trade Policy 25 Lecture 8 Political Economy of Trade Policy 26 Lecture 8 Political Economy of Trade Policy 27 Top ten lobbyists Lecture 8 Political Economy of Trade Policy 28 Politicians become lobbyists Lecture 8 Political Economy of Trade Policy 29 Decision making problems (4) Effect of uncertainty Suppose government considers trade liberalisation 40% export industry 60% import competing industry Export industries gain Import competing industries 1/3 will start to export Lecture 8 Political Economy of Trade Policy 30 Policy should be adopted Uncertainty (cont.) • Import competing industries • 1/3 will gain • 2/3 chance to lose out • Whole group expected gain -1/3 Lecture 8 Political Economy of Trade Policy 31 Status quo bias agaist trade liberalisation Exampe why reciprocity in trade negotiations is often necesarrry: gains need to be large enough Empirical evidence • Main contribution: trade policy is endogenous! = dependent variable • Huge implications • Empirical research challenging • Historical analysis, case studies • Associations between protection and political and economic variables, geographic concentration, institutions, etc. • Voting behaviour of politicians Lecture 8 Political Economy of Trade Policy 32 Recent empirical study • Exposure to offshoring and the politics of trade liberalisation by Erica Owen • Interesting study on factors that influence politician’s voting behaviour • Several votes in American House of Representatives on Free Trade Agreements • Link to earlier trade theories • Adds two important new elements • Link between trade liberalisation and Foreign Direct Investment in the form of offshoring • Occcupation and tasks in addition to industry interests and factors of production Lecture 8 Political Economy of Trade Policy 33 Offshoring and jobs • Outsourcing of tasks has been going on for a long time • Offshoring is the same, but then across international borders • Rapidly increasing in scale • Growing diversity of activities • Remember the growing importance of trade in services • Value chain of a firm more and more internationally fragmented • Increasingly jobs and occupations are affected rather than (parts of) industries or factors of production • Also increasingly higher skilled jobs are at risk • For instance head accountant and assistants • Head accountant can offshore asistants’ work Lecture 8 Political Economy of Trade Policy 34 How to analyse this • Median voter model: politician wants to be re-elected • Needs to find balance between positive effects of trade and negative effects among specific interest groups • Traditonal elements • Heckscher-Ohlin = specific factors • For instance skilled versus unskilled labour • Ricardo = productivity differences between sectors • New element • Offshorability (or tradability) of tasks • Tasks that are not location specific and do not require face-to-face contact • These are likely to be subject to competition from foreign labour • Occupation-based lobbying is becoming more prevalent Lecture 8 Political Economy of Trade Policy 35 Research questions Lecture 8 Political Economy of Trade Policy 36 Cases analysed Lecture 8 Political Economy of Trade Policy 37 TPA Trade Promotion Authority; power to President to negotiate reciprocal agreements with partner countries Control variables by district • Offshorability = workers in offshorable + highly offshorable jobs / labour force • % of skilled workers (comparative advantage) • Employment share in export industries • Employment share in import-competing industries • Republican dummy • Unemployment % • Region dummies • Past corporate contributions • Past labour contributions Lecture 8 Political Economy of Trade Policy 38 Lecture 8 Political Economy of Trade Policy 39 Additional analysis • Is there also effect on the language and arguments that politicians use in the debates? • Keywords: workers, jobs, offshor*, outsourc*, white-collar, exporting jobs, shipping jobs • Text analysis of the transcripts • Rate of labour speech = number of labour keywords / total number of words Lecture 8 Political Economy of Trade Policy 40 Lecture 8 Political Economy of Trade Policy 41 Main points • Trade policy becomes endogenous • Economic self interest and social concerns approaches • Provide explanations for sub-optimal policy choices • Median voter model: trying to explain policy choices • Intensity of preferences • Rational ignorance and abstention • Effect of lobbies • Status quo bias • Empirical evidence • H-O, Ricardo, tradability of tasks • Politicians clearly vote according to interest of constituents • Although trade liberalisation increases overall welfare! Lecture 8 Political Economy of Trade Policy 42 Discussion point Endogenous policy making makes it easier to understand policy choices but more difficult to identify their effects? Lecture 8 Political Economy of Trade Policy 43 Discussion point The EU should strongly limit the presence and actions of lobby organisations in Brussels Lecture 8 Political Economy of Trade Policy 44 Discussion point The growing tradability of occupations / tasks changes the debate on globalisation and trade liberalisation Lecture 8 Political Economy of Trade Policy 45