The Political Economy of The Political Economy of Trade PolicyTrade Policy

Government PoliciesGovernment Policies

Political Models of Trade PolicyPolitical Models of Trade Policy

How is trade policy determined?How is trade policy determined?

Models that address this question:Models that address this question:

1.1. Median voter theoremMedian voter theorem

2.2. Collective action – interest groups theoryCollective action – interest groups theory

Median Voter TheoremMedian Voter Theorem

The median voter theorem predicts that democratic The median voter theorem predicts that democratic political parties may change their policies to court the political parties may change their policies to court the voter in the middle of the ideological spectrum (the voter in the middle of the ideological spectrum (the median voter).median voter).

Suppose that this ideological spectrum is defined only by Suppose that this ideological spectrum is defined only by a tariff rate policy.a tariff rate policy.– And suppose that voters can be ranked according to whether And suppose that voters can be ranked according to whether

they desire high or low tariff rates.they desire high or low tariff rates.

– Both parties will offer the same tariff policy to court the median Both parties will offer the same tariff policy to court the median voter (the voter in the middle of the spectrum) in order to capture voter (the voter in the middle of the spectrum) in order to capture the most votes on either side of the median voter.the most votes on either side of the median voter.

– A policy that inflicts large losses on a few people (import-A policy that inflicts large losses on a few people (import-competing producers) but benefits a large number of people competing producers) but benefits a large number of people (consumers) should be enacted into law.(consumers) should be enacted into law.

Collective ActionCollective Action

Political activity is often described as a Political activity is often described as a collective action collective action problemproblem: :

– While consumers While consumers as a groupas a group have an incentive to advocate free have an incentive to advocate free trade, each trade, each individualindividual consumer has no incentive because his consumer has no incentive because his benefit is not large compared to the cost and time required to benefit is not large compared to the cost and time required to advocate free trade.advocate free trade.

– Policies that impose large losses for society as a whole but small Policies that impose large losses for society as a whole but small losses on each individual may therefore not face strong losses on each individual may therefore not face strong opposition.opposition.

– For those groups who may suffer large losses from free trade For those groups who may suffer large losses from free trade (for example, unemployment), each individual in that group has (for example, unemployment), each individual in that group has a strong incentive to advocate the policy he desires.a strong incentive to advocate the policy he desires.

Which Industries Are Protected?Which Industries Are Protected?

AgricultureAgriculture: in the US, Europe and Japan farmers make : in the US, Europe and Japan farmers make up a small fraction of the electorate but receive generous up a small fraction of the electorate but receive generous subsidies and trade protection.subsidies and trade protection.

– European Union’s Common Agricultural Policy (CAP)European Union’s Common Agricultural Policy (CAP)

– Japan’s 1000% tariff on imported riceJapan’s 1000% tariff on imported rice

– America’s sugar quota.America’s sugar quota.

ManufacturingManufacturing: cars in India and Indonesia, steel in the : cars in India and Indonesia, steel in the US.US.

ServicesServices: banking in many countries, airlines almost : banking in many countries, airlines almost everywhere.everywhere.

Costs of ProtectionCosts of Protection

Labor ProtectionLabor Protection

International Trade NegotiationsInternational Trade Negotiations

Since 1944, much of the reduction in tariffs and other Since 1944, much of the reduction in tariffs and other trade restrictions came about through international trade restrictions came about through international negotiations.negotiations.– The The General Agreement of Tariffs and TradeGeneral Agreement of Tariffs and Trade was begun in was begun in

1947 as a provisional international agreement 1947 as a provisional international agreement ITO negotiations in Havana, 1948ITO negotiations in Havana, 1948

– It was replaced by a more formal international institution called It was replaced by a more formal international institution called the the World Trade Organization (WTO)World Trade Organization (WTO) in 1995. in 1995.

Multilateral negotiation mobilize exporters to support free Multilateral negotiation mobilize exporters to support free trade if they believe export markets will expand.trade if they believe export markets will expand.– This support would be lacking in a unilateral push for free trade.This support would be lacking in a unilateral push for free trade.

– This support counteracts the support for restricted trade by This support counteracts the support for restricted trade by import-competing groups.import-competing groups.

– Multilateral negotiations also help avoid a trade wars, where Multilateral negotiations also help avoid a trade wars, where each country enacts trade restrictions each country enacts trade restrictions even if it is in the interest even if it is in the interest of all countries to have free tradeof all countries to have free trade

World Trade OrganizationWorld Trade Organization

The WTO negotiations addresses trade restrictions in The WTO negotiations addresses trade restrictions in at least 3 ways:at least 3 ways:

1.1. Reduction of tariff ratesReduction of tariff rates through multilateral through multilateral negotiations.negotiations.

2.2. BindingBinding: a tariff is “bound” by having the imposing : a tariff is “bound” by having the imposing country agree not to raise it in the future.country agree not to raise it in the future.

3.3. Prevention of non-tariff barriersPrevention of non-tariff barriers: quotas and export : quotas and export subsidies are changed to tariffs because the costs of subsidies are changed to tariffs because the costs of tariff protection are more apparent.tariff protection are more apparent.

– Exceptions: Exceptions:

subsidies for agricultural exports.subsidies for agricultural exports.

““market disruptions” caused by a surge in imports.market disruptions” caused by a surge in imports.

How are trade talks conducted?How are trade talks conducted?

World Trade OrganizationWorld Trade Organization

The WTO was founded on a number of agreements: The WTO was founded on a number of agreements:

– General Agreement on Tariffs and Trade (GATT)General Agreement on Tariffs and Trade (GATT)

– General Agreement on Tariffs and Services (GATS)General Agreement on Tariffs and Services (GATS)

– Agreement on Trade-Related Aspects of Intellectual Property Agreement on Trade-Related Aspects of Intellectual Property (TRIPS)(TRIPS)

The dispute settlement procedure: The dispute settlement procedure:

– a panel of WTO experts to rule upona panel of WTO experts to rule upon

– The cases are settled fairly quickly: not more than 15 months.The cases are settled fairly quickly: not more than 15 months.

– A country that refuses to adhere to the panel’s decision may be A country that refuses to adhere to the panel’s decision may be punished by allowing other countries to impose trade restrictions punished by allowing other countries to impose trade restrictions on its exports.on its exports.

WTO DisputesWTO Disputes

Preferential Trading AgreementsPreferential Trading Agreements

PTAs are trade agreements between PTAs are trade agreements between countries in which they lower tariffs for countries in which they lower tariffs for each other but not for the rest of the world.each other but not for the rest of the world.

Under the WTO, such discriminatory trade Under the WTO, such discriminatory trade policies are generally not allowed:policies are generally not allowed:

– the “most favored nation” (MFN) principle.the “most favored nation” (MFN) principle.

– An exception to this principle is allowed only if An exception to this principle is allowed only if the lowest tariff rate is set at zero. the lowest tariff rate is set at zero.

Preferential Trading AgreementsPreferential Trading Agreements

zero tariff rates agreements :zero tariff rates agreements :1.1. A A free trade areafree trade area: an agreement that allows : an agreement that allows

free trade among members, but each member free trade among members, but each member can have its own trade policy towards non-can have its own trade policy towards non-member countriesmember countries

– NAFTANAFTA

2.2. A A customs unioncustoms union: an agreement that allows : an agreement that allows free trade among members, and requires a free trade among members, and requires a common external trade policy towards non-common external trade policy towards non-member countries.member countries.

– European UnionEuropean Union

Multi-lateral Trade AgreementsMulti-lateral Trade Agreements

Preferential Trading AgreementsPreferential Trading Agreements

Preferential trading agreements increase national Preferential trading agreements increase national welfare when new trade is created, but not when existing welfare when new trade is created, but not when existing trade from the outside world is diverted to trade with trade from the outside world is diverted to trade with member countries.member countries.

Trade creation Trade creation – occurs when high cost domestic production is replaced by occurs when high cost domestic production is replaced by low low

cost imports from other memberscost imports from other members..

Trade diversion Trade diversion – occurs when low cost imports from non-members are diverted to occurs when low cost imports from non-members are diverted to

high cost imports from member nations.high cost imports from member nations.