Chapter 10. Arguments for and against protectionism

Link to syllabus

Jobs, Jobs, JobsData relating to Mfg. & Automotive Sector

Externalities Theory of Second BestSpecificity RuleInfant Industry

Politics of ProtectionismLobbyingPolitical Economy of Voting

It is not just a theoretical issue. Remember, some argue that the cause of job loss is technological change, not trade policy.

Employment in the US, Total Non-Farm

Employment in the US. Total Private

Source: www.bls.gov

Non-farm Employment, 2007; 000s US Michigan

Total 137,623 4,626

Private 115,420 3,969

Goods Producing 22,221 791

Nat'l Resource & Mining 723 8

Construction 7,614 166

Manufacturing 13,884 617

Non-Gov't Service 93,199 2,814

Trade, Transport, Utilities 26,608 788

Information 3,029 66

Financial 8,308 211

Business Services 17,962 573

Education & Health 18,327 595

Leisure & Hospitality 13,474 404

Other 5,491 177

Government 22,203 657bls.gov

Employment in the US. Private, Service-Providing

Employment in the US. All Governments

Source: www.bls.gov

Employment in the US. Manufacturing, 1,000s

Source: www.bls.gov

US Transportation EquipmentEmployment, in thousands

0

500

1,000

1,500

2,000

2,500

1950 1960 1970 1980 1990 2000 2010

Michigan Total Manufacturing

Michigan Transportation Equipment

BLS data

900

800

700

600

350

300

250

200

Notice:Canada,Mexico

Source for the next Slides: Klier and Rubenstein (2006) The New Geography of the U.S. Automobile Industry

Cost of protecting a job: p. 210 (new chart this edition, but same message as before)

(More elaborate data on next slides)

Ultimate data source is Institute for International Economics

Focus on Labor: Cost of protecting a job in the US. Previous edition: page 210

Ultimate source is research by Institute for International Economics

Focus on labor: Cost of protecting a job in Europe. Previous edition. Page 211

Figure 10.1 p. 201 Incentive Distortions and their Effects.

Theory of Second Best p. 202

If several conditions are necessary for a maximum, and one is constrained (not attainable - due to a distortion), then for the second best, other conditions might need to be constrained too.

Our application is to free trade in a competitive environment.

Bend one rule, you might have to bend others, as well.

Text refers to this situation as incentive distortions. Can be caused by externalities or spillovers, or gov’t policies-taxes.

Some free traders call it the theory of second worst.

Example: standing to reach the highest point on the side of a hill.

Specificity rule (p. 204)

It is usually more efficient to use the government policy tool that actsas directly as possible on the source of the distortion separating privateand social benefits or costs.

Although a barrier against imports can be better than doing nothing ina second best world, the specificity rule shows us that some other instrument is usually more efficient than a trade barrier.

Standard example is that a quota is a better tool to save jobs thana tariff, because it doesn’t distort prices for consumer.

Figure 10.2 page 206 Two ways to promote import-competing production

Economic cost of the subsidy is less than that of the tariff.

Figure 10.3 page 209. The infant industry argument

Sdn: domestic supply now. Sdf: domestic supply in the future.

Figure 10.4 P. 225. Can an Import Barrier be Better than Doing Nothing?

If so, is it the Best Policy?

Attempt at SummaryGeneral principle that free trade is best: assumes full employment, and redistribution of benefits

Issue of optimum tariff for large country. Or a tariff that maximizes government revenue. [More important in theory than in the real world]

Subsidies are better (less worse) than tariffs

That principle is an example of the specificity principle, which says that other instruments are usually less harmful for the economy than tariffs, as they can be directed more specifically at an assumed problemAn important justification for tariffs is that the industries protected have positive externalities for societies, such as R&D, improving management skills or workers’ attitudes. Subsidies do this better, of course

A related story is the infant industry argument. (Subsidies are still better)

Conversation about National Defense: pp. 217-18

• A country must have access to products to maintain the national defense, especially because imports may not be readily available during times of hostilities.

• Apply the specificity rule:• Some products can be kept in stockpiles. In this case,

imports during peacetime can be used to build the stockpiles.

• National production capabilities are needed for other products. Best to use a subsidy to building or maintaining national production capabilities.

“Political Economy” of Protectionism

Political economy: idea that policies can be explained by a direct analysis of the economic interests which may be affected. Sometimes called Public Choice--Appeals to extremes of the political spectrum; can be seen as a form of economic determinism, as is Marxism,...

--Alternative stories would include "power", ideology, personalities, etc.

--Overlaps with Political Science. (& is a hot topic) Note that Economics and Political Science both evolved from “Political Economy” Names: Richard E. Baldwin, J. Bhagwati, M. Olson, G. Tullock, Dennis Mueller

Why don't we have more free trade? In particular, why is there so much trouble expanding GATT/WTO, and expanding NAFTA?

"Rational Voter;" If everybody can be made better off with free trade, then all should support it.

Because that doesn’t happen, we should look for weaknesses in the model’s assumptions, and apply specificity rule to improve things. For example, applicability will be limited by market imperfections, such as imperfect information and time discounting. Or, maybe we don’t have full employment. Maybe the costs of re-location of labor or capital outweigh the benefits, to those people, of free trade.Or, maybe the political system does not always redistribute benefits.The ‘specificity rule’ suggests several areas of improvement that would facilitate the adoption of free trade.

Application of Voting Models to the analysis of trade policy.

Voting models, continued

Lobbying distorts incentives from individual voter to the representative.It is widely believed that lobbying (a.k.a. directly unproductive activity, rent seeking activities) has grown in importance in the last two decades

“Majority Rule" in direct voting. Consumers should out-vote producer interests hurt by free trade. Unclear how a direct vote would go, if disputed only among producers. [verdict, not helpful]

"Representative system" (indirect voting, as in U.S.) Goes beyond rational voter, looking at Congressional reps as intermediaries. Problems arise due to information, lobbying. Votes depend on diversity of districts, time span (longer elections, more far-sighted), potential importance of factors such as leadership position (e.g. Gingrich, Boehner, Dingel), incumbency, strength of party control. Studies also emphasize importance of short term macro factors such as unemployment and inflation.

What Explains Lobbying?Incentives to lobby depend on size of potential change, ability to suppress "free rider“ problem (such as with unions or business associations), dispersion/concentration of affected people, legal arrangements such as taxes, permission for foreign lobbyists (foreigners benefit from VERs). Studies show movement towards greater consistency along sectoral, as opposed to Heckscher-Ohlin lines.

Size of change of income (total, or per person) depends on: - Specificity of policy (titanium or tobacco, vs. “food" or “manufacturing"); - Complications due to presence of intra-industry trade/outsourcing, especially foreign, which is itself related to presence of MNCs; - Cost of reallocating resources (higher in a stagnant economy, or for industry specific skills; less if there is trade adjustment assistance; will also depend on age, unionization).Obviously the extent of lobbying is affected by legislation (about which mt knows nothing).

Some Conclusions1) Rational voter model, alone, doesn't explain much. But we can use it to argue that deviations (protectionism) are due to incorrect assumptions, as well as free riders--especially among consumers--costs of information, and limited time horizons.

2) Nevertheless, modifications of this model appear to be able to explain some political behavior, by suggesting that benefits of expansion of GATT/WTO will be small compared to returns from lobbying against it.

3) The Representative model leads to an emphasis on lobbying, which seems to have increased, and to be more important, now that cold war concerns are less. Recent U.S. legislation appears to increase power of lobbyists.

4) Several aspects of globalization should tend to lessen the demand for protectionism, especially the high current rate of technological change, MNCs and outsourcing. Also, the cost of tariff war is perceived to be much higher.

Are There Any Conclusions about Policy from the Political Economy Analysis? What Can Be Done to Facilitate Trade

Expansion?

1) Improve information; on effects of tariffs, on voting policies of our representatives in Congress.

2) Pass legislation to limit the returns to lobbying.

3) Facilitate income redistribution as per Community Indifference Curve analysis. Trade adjustment programs lower cost of relocation.

4) Note that recent changes in U.S. trade laws, concerning import surges, etc., make NTBs easier.

Brief Review of US Trade Policy

1. Tariffs were a major source of gov’t revenue, pre-WWI. Tariff policy depended on fiscal needs.2. One cause of WWI was trade conflicts (Germany, England, France)3. Smoot Hawley was widely recognized as damaging

Since WWII1. Trade policy often mixed with politics; promoting broad geo-political goals like restraining Communism and promoting democracy.2. Increasing domestic economic pressure, especially given the long term decline in protectionism. What is Obama’s position?3. Reversal of positions between Republicans and Democrats, paralleling a reversal of positions by business, labor, and farm sector4. Increased use of NTBs.

Recent Initiatives in US Trade Policy

1962 Trade expansion Act: across the board tariff reductions, trade adjustment assistance, Kennedy Round of GATT1974 Trade Act - supported Tokyo Round, and Section 201 relief from ‘surges’ in imports Section 232 trade restrictions for ‘national security’ Section 301 retaliate against countries applying discriminatory policies towards US exports Section 701 recognizes injury from foreign subsidies to production Section 731 anti-dumping provisions.

Many of these increase administrative discretion, a.k.a. NTB

Super 301 (1988) USTR to send to congress a list of countries with unfair trading policies.

Current Major Policy Areas for US Trade Issues

Europe: CAP, MNCs (in and outward), antitrust, IP

Japan: US Trade deficit (but US pressure has relaxed)

China: rapid growth in US trade deficit, ‘human rights’

Cuba: Helms-Burton blockade. Extraterritoriality

FTAs with several countries (third world).

Trade Policy Issues for Developing Countries

Historical resentment: free trade was imposed on colonies – a.k.a. the ‘Imperialism of Free Trade’ hindering industrialization

Experiences of Japan, Korea, Taiwan etc. are widely interpreted as supportive of infant industry protectionism.

Many experiences in LDCs with trade liberalization have not been successful. Especially true when undertaken in a context of other reforms (exchange rates, inflation).

China and India are unexpectedly successful with trade-led growth.

Stalemate in WTO is often seen as resulting from protectionism in North

Question # 5 page 227

Can you describe plausible conditions under which a nation would benefit from subsidizing imports of a good?

Question # 11 p. 228

In an earlier chapter, we discussed the one-dollar one-vote metric. Ifpolitical decisions in a small country were based on this metric, whatsort of protectionism would the country have?

Question #1 p. 227

A Single firm’s innovations in production technology often benefitthe production of other firms, because these other firms learn about the new technology and can use ita) Is there an externality here?b) How would an economist rank the following two policies? i) A tariff on imports, to encourage production and the technology ii) A subsidy on domestic production to encourage productionc) What third policy (a tax or subsidy or something) would the economist recommend as even better?

October 28, 2006 NYT Democrats Get Late Donations From Business

By JEFF ZELENY and ARON PILHOFER WASHINGTON, Oct. 27 — Corporate America is already thinking beyond Election Day, increasing its share of last-minute donations to Democratic candidates and quietly devising strategies for how to work with Democrats if they win control of Congress.The shift in political giving, for the first 18 days of October, has not been this pronounced in the final stages of a campaign since 1994, when Republicans swept control of the House for the first time in four decades. Though Democratic control of either chamber of Congress is far from certain, the prospect of a power shift is leading interest groups to begin rethinking well-established relationships, with business lobbyists going as far as finding potential Democratic allies in the freshman class — even if they are still trying to defeat them on the campaign trail — and preparing to extend an olive branch the morning after the election.Lobbyists, some of whom had fallen out of the habit of attending Democratic events, are even talking about making their way to the Sonnenalp Resort in Vail, Colo., where Representative Nancy Pelosi of California is holding a Speaker’s Club ski getaway on Jan. 3. It is an annual affair, but the gathering’s title could be especially apt for Ms. Pelosi, the House minority leader, who will be on hand to accept $15,000 checks, and could, if everything breaks her way, become the first woman to be House speaker.

Externalities (pp. 183-184)

External costs SMC> p (=MB=MC=SMB) e.g. pollution

External benefits SMB>P (=MB=MC=SMC) e.g. education

Distorting tax P with tax > SMC

Distorting subsidy P with subsidy < SMC

Monopoly power P>SMC

Monopsony power P < SMB (single firm dominates labor market-not done in this book)

First-best all private incentives line up with benefits and costs to society as a whole

Second best there are distortions. Externalities or spillovers.

Pigou’s suggestion was tax or subsidy. Coase talks about expanding property rights—not pursued here.

Specificity rule—go directly to source of distortion.