1. Political Economy of Trading States
International Political Economy
Prof. Tyson Roberts

2. Lecture Goals Supply & demand model
Winners & losers from protectionist policies
Review and extension of factor & sector models, including the role of institutions

3. Supply and Demand Model

4. Demand curve Three students Draw a demand curve
1 loves coffee, would pay $5 (or less) per cup
1 likes coffee, would pay $3 (or less) per cup
1 only drinks coffee if it’s cheap, would pay $1 (or less) per cup
Draw a demand curve
How many cups would sell at $1? At $3? At $5?
Put price on the vertical axis
Put quantity on the horizontal axis

5. Demand curve
Price 5 3 D 1
Quantity 1 2 3

6. Supply Curve Three baristas Draw a supply curve
1 loves to make coffee, will make cup for $1 (or more)
1 likes to make coffee, will make cup for $3 (or more)
1 dislikes making coffee, will make for $5 (or more)
Draw a supply curve
How many cups will be made if price is $1? $3? $5?
Price on vertical axis, quantity on horizontal axis

7. Supply curve
Price S 5 3 D 1
Quantity 1 2 3

8. (if you know the answer, please ask your neighbors if they need help)
Equilibrium
Assume all cups of coffee must be sold at the same price
How many cups of coffee will be bought and sold, if everyone makes a decision they won’t regret? Why?
At what price will the coffee be sold? Why?
(if you know the answer, please ask your neighbors if they need help)

9. Searching for equilibrium
Price S
3 willing to make but only 1 willing to buy, price too high 5 3 D 1
Quantity 1 2 3

10. Searching for equilibrium
Price S 5 3 D 1
3 willing to buy but only 1 willing to make, price too low
Quantity 1 2 3

11. Finding equilibrium! Price S 5 2 willing to buy ,
2 willing to make, price just right
EQUILIBRIUM 3 D 1
Quantity 1 2 3

12. Important for this week’s problem set:
Note that 3 different baristas are selling coffee
If all cups of coffee are equivalent, they are analyzed using one supply curve & one demand curve => all coffee has one price
If the coffees are not substitutes, then each needs its own supply & demand curves => each coffee has its own price

13. If there is no trade, Home market price and quantity is determined by home supply and demandPH
Source: Krugman, Obtsfeld, & Melitz (2012)

14. Trade enables lower prices and more quantity for consumers, but lower prices (and market share) for comparative disadvantage producers PH
Source: Krugman, Obtsfeld, & Melitz (2012)

15. Trade protection (e.g., tariffs) increase prices and reduces quantity for consumers (& producers who use the tariffed good), but higher prices for comparative disadvantage producers
Source: Krugman, Obtsfeld, & Melitz (2012)

16. Society-based models: Production-induced preferences & coalitions
(Mobile) Factor Model
Factors mobile (in short run) across industries
Abundant factor benefits from trade (higher returns)
Scarce factor benefits from protection (higher returns)
Coalitions: Abundant factors vs. scarce factors

17. Society-based models: Production-induced preferences & coalitions
(Mobile) Factor Model
Sector/Specific Factors Model
Factors mobile (in short run) across industries
Abundant factor benefits from trade (higher returns)
Scarce factor benefits from protection (higher returns)
Coalitions: Abundant factors vs. scarce factors
Factors immobile (in short run) across industries
Factors employed in abundant factor-intensive industries benefit from trade
Factors employed in scarce factor-intensive industries benefit from protection
Coalitions: Export-oriented vs. import-competing industries

18. Organizing Interests: The Collective Action Problem and Trade Policy Demands

19. Producers of tradeables
Collective action and trade protection: Producers lobby governments more than consumers
Consumers
Benefit from trade (lower prices)
Are diffused
Marginal benefit of lower price for each good is small
Producers of tradeables
Benefit from
Protection in own country (higher prices)
No protection in foreign country (access to markets)
Are concentrated
Marginal benefit of protection/access is large

20. Political Institutions & Trade Policy
Majoritarian vs. PR electoral system
Majoritarian increases voice of minority interests, e.g. sector-based interests (based on geography)
PR increases voice of larger groups, e.g., class or factor interests, or consumers

22. Example of tariffs, WTO, & distribution of benefits
“We had a tire case in which they were flooding us with cheap … Chinese tires. And we put a stop to it and as a consequence saved jobs throughout America. I have to say that Governor Romney criticized me for being too tough in that tire case; said this wouldn’t be good for American workers and that it would be protectionist. But I tell you, those workers don’t feel that way. They feel as if they had finally an administration who was going to take this issue seriously.” – Barack Obama, October 22, 2012

23. Coalition for tire protection (from podcast)
Tire company union
Tire company owners
Does this comply with the factor or sector model?
Does this imply factors are mobile or immobile?

24. “It’s not like you were going to take a 52-year-old guy and send him to internet school.” (Podcast)

25. China responds to US anti-dumping tire tariff with anti-dumping chicken part tariff (US wins on tires, chicken parts still in dispute)

26. Tire tariffs saved/created ~1200 jobs in Ohio, etc
Tire tariffs saved/created ~1200 jobs in Ohio, etc. (swing states) (Hufbauer & Lowry 2012)

27. Estimated cost to consumers in higher tire prices estimated at $1
Estimated cost to consumers in higher tire prices estimated at $1.1 billion, or $900,000 per job

28. Another tariff case (LaFaive 2002, Tran 2003)
President Bush raised tariffs on steel in 2002
Winners: Estimated 4,400 – 8,900 steel-sector jobs in MI & PA (swing states)
Losers: Estimated decrease in national income $ billion; lost jobs in steel-using industries
WTO ruled against US, authorized EU to retaliate with tariffs against FL oranges & Harley-Davidsons (WI, PA, etc.)
Bush reduced steel tariffs in 2003

30. Take-aways
While trade has many obvious benefits, protectionism is a common strategy for many reasons
Collective action challenges (more voice for producers than consumers)
Winners vs. losers among producers (factors or sectors)
Some countries may benefit in the long run from targeted protection policies (Lecture 8)

31. The role of veto players
Veto player must agree for policy to change
More veto players => more policy stability
Institutional veto points
President, lower house (HR), upper house (Senate)
Partisan veto players
Parties in institutional veto points
Parties in coalition governments

32. If there is one veto player, he can get his ideal policy choice
Democrats   SQ
Taxes on the rich
Republicans
Community College
spending

33. If there are two veto players, the possible policy outcomes are narrowed – both must agree
Democrats   SQ
Taxes on the rich
Joint gains
Republicans 
Community College
spending

34. If there are three veto players, the possible policy outcomes are narrowed further still – all must agree
Democrats in Senate
President    SQ
Taxes on the rich
Republicans 
Joint gains
Community College
spending

35. Consumption-induced preferences in Ricardo-Viner
“Real” income = Nominal income (wage, profit, rent) ÷ Cost of consumption
Trade reduces prices of scarce factor-intensive goods (imports cheaper than domestic) but not abundant-factor intensive goods
If labor is mobile, net gain/loss depends on wage effect and consumption effect

36. “Ratio of efficiency to redistribution gains” (Rodrik pp. 57-58)
Effects of trade:
Increased efficiency for national economy
Move to comparative advantage => gains at national level
Redistribution of income
Comparative advantage factors/sectors win
Disadvantage factors/sectors lose
In US: capital owners & high tech innovators win, low-skilled workers (and their employers) lose
In China: low-skilled workers (and their employers) win

37. “Ratio of efficiency to redistribution gains” (Rodrik pp. 57-58)
In China, pre-market reforms, very large efficiency gains from trade
(Almost) everyone wins a lot from free trade
In US, most efficiency gains from free trade have already been achieved
Everyone gains a little from more free trade (slightly lower prices)
Some gain a lot from free trade (international investors, high tech innovators, etc.)
Some may lose a lot (long-term unemployment)

38. “Blue Collar Blues” Robert Lawrence (2008):
Rich have become much richer (capital)
But blue collar has not become much poorer relative to middle class (low vs. high skilled labor) since trade with China. Why? Per Lawrence:
Many low-skill intensive goods no longer produced in US (now imported)
US production processes are less labor intensive than China’s

39. Data challenges Economist article: Elsby, Hobijn, Sahin (2013):
Limited fine-grained wage data make conclusions difficult
Elsby, Hobijn, Sahin (2013):
Self-employed are often excluded from wage statistics
When self-employed are included (at market wage rates), labor share of income is higher than previously thought

40. Composition of nonfarm business sector income
Profits
Taxes
Labor compensation
Rent, Interest
Self-employed income

41. By all measures, labor share of income in US fell after 1980 (when China entered world market) and again after 2000 (increased offshoring, etc.)

42. Wages dropped heavily in manufacturing, where equipment costs didn’t fall. Suggests more capital-intensive processes are NOT major source of labor share decrease since 1980s

43. Exposure to import competition is a major source of labor share reductions in the US since 1980s

44. If nation wins in aggregate, then winners should be able to compensate losers => Pareto optimal
Loser from free trade
Accept free trade
Block free trade
Winner from free trade
Compensate loser if free trade
8, 4
4, 2
Refuse to compensate loser
12, 0
But if winners from free trade can influence policy more than losers (e.g., lower collective action costs), winners can achieve free trade benefits without compensating losers

45. Consumption-induced preferences in Ricardo-Viner
“Real” income = Nominal income (wage, profit, rent) ÷ Cost of consumption
Trade reduces prices of scarce factor-intensive goods (imports cheaper than domestic) but not abundant-factor intensive goods
If labor is mobile, net gain/loss depends on wage effect and consumption effect

46. Assumes labor is mobile Source: Alt & Gilligan
Trade increases wages
Trade reduces wages
Trade reduces cost of living
Small cost of living impact
Trade reduces cost of living
Small cost of living impact
Assumes labor is mobile
Source: Alt & Gilligan

47. Example Assume What do we expect regarding
US is land-abundant & capital abundant relative to trade partners
Low-skilled labor is mobile across industries
Workers primarily consume domestic goods
What do we expect regarding
Workers trade policy preferences?
Political coalitions (e.g., between labor, farm-owners, Textile factory owners, auto factory owners?)

48. Assumes labor is mobile Source: Alt & Gilligan
Trade increases wages
Trade reduces wages
Trade reduces cost of living
Small cost of living impact
Land,
Capital
Trade reduces cost of living
Labor
Small cost of living impact
Assumes labor is mobile
Source: Alt & Gilligan

49. Prediction Low-skilled labor favors protection from trade
Import-competing industries also favor protection:
Scarce-factor is labor, so import competing industry is labor-intensive, e.g., textiles
Predicted coalition: Low-skilled labor & textile factory owners

50. Collective action problem Example 1
Assume workers
Are few in number
Receive large benefit per person from trade policy
Are not mobile across industries
How do these affect labor’s ability to act collectively?

51. Collective action problem Example 2
Assume consumers
Are many in number
Receive small benefit per person from trade policy
Can easily switch from one product to another
How do these affect consumers’ ability to act collectively?

52. Collective action problem Example 1
Assume workers
Are few in number
Lower costs to organize if per-person transaction costs
More likely that each individual will have major impact
Lower likelihood of free-riding
Receive large benefit per person from trade policy
More likely that expected benefit > expected cost
Are not mobile across industries
Lower likelihood of free-riding – high opportunity costs to organizing

53. Collective action problem Example 2
Assume consumers
Are many in number
High costs to organize if per-person transaction costs
Less likely that each individual will have major impact
High likelihood of free-riding
Receive small benefit per person from trade policy
Unlikely that expected benefit > expected cost
Can easily switch from one product to another
High likelihood of free-riding – consumers will switch to other products rather than organize

54. Sugar quota winners: sugar farms & some foreign governments Sugar quota losers: consumers, producers using sugar inputs, would-be (foreign) sugar exporters
Source: Krugman, Obtsfeld, & Melitz (2012)

55. Jose & Alfonso Fanjul of Florida Crystals

56. US sugar policies cost consumers $1
US sugar policies cost consumers $1.5B per year, transfers $1B to US sugar growers. Free trade would benefit US consumers, US candy producers, and (some) trade partners.
Potential free trade winners
Free trade winners
Source: Elliott 2005
Free trade losers

57. What determines political winners in sugar trade policy conflict?
Collective action problem
Mobility of factors (labor, capital more mobile than land)
Size of groups (sugar farmers fewer than consumers, etc.)
Net gain per actor
Political institutions…

58. Collective Action Cost
Collective action costs & political institutions may also matter (Alt & Gilligan)
Collective Action Cost
High
Low
Factors Mobile & Majoritarian Inst. (e.g., democracy, not oligarchy)
Rampant free riding
No trade policy coalitions
Exit (?)
Rogowski
Factors Mobile &
Non-maj. Inst. (e.g., oligarchy)
Trade policy coalitions
Class-based coalitions possible, but not necessary for victory
Factors Specific &
Majoritarian Inst.
Individual interest groups unable to affect trade policy
Consumer groups inactive
Universalistic logroll (?)
Cross sector coalitions (logrolling) or coalitions with labor
Consumer groups active
Factor Specific &
Non-maj. Inst.
Standard trade policy
Model (Pareto,Olson, etc)
Lobbying for protection
Cross sector coalitions (logrolling) or coalitions with labor possible, but not necessary for victory

59. Political Institutions & Trade Policy
Majoritarian vs. Non-majoritarian/elitist political system
Majoritarian increases voice of labor
Non-majoritarian may increase voice of minorities, perhaps capital (in factor model) or “special interests” (in sector model)
Majoritarian vs. PR electoral system
Majoritarian increases voice of minority interests, e.g. sector-based interests (based on geography)
PR increases voice of larger groups, e.g., class or factor interests, or consumers

60. US Political System Majoritarian or non-majoritarian political system?
How does this affect sugar policy example?
Majoritarian or PR electoral system?

61. US Political System
Majoritarian or non-majoritarian political system? Majoritarian (relatively)
How does this affect sugar policy example?
Doesn’t(?) – same outcome possible with non-majoritarian
Majoritarian or PR electoral system? Majoritarian
Farmer & sugar company votes capture legislators

62. Based on the sugar policy example, where would you place the US?
Collective Action Cost
High
Low
Factors Mobile & Majoritarian Inst. (e.g., democracy, not oligarchy)
Rampant free riding
No trade policy coalitions
Exit (?)
Rogowski
Factors Mobile &
Non-maj. Inst. (e.g., oligarchy)
Trade policy coalitions
Class-based coalitions possible, but not necessary for victory
Factors Specific &
Majoritarian Inst.
Individual interest groups unable to affect trade policy
Consumer groups inactive
Universalistic logroll (?)
Cross sector coalitions (logrolling) or coalitions with labor
Consumer groups active
Factor Specific &
Non-maj. Inst.
Standard trade policy
Model (Pareto,Olson, etc)
Lobbying for protection
Cross sector coalitions (logrolling) or coalitions with labor possible, but not necessary for victory

63. Based on the sugar policy example, where would you place the US?
Collective Action Cost
High
Low
Factors Mobile & Majoritarian Inst. (e.g., democracy, not oligarchy)
Rampant free riding
No trade policy coalitions
Exit (?)
Rogowski
Factors Mobile &
Non-maj. Inst. (e.g., oligarchy)
Trade policy coalitions
Class-based coalitions possible, but not necessary for victory
Factors Specific &
Majoritarian Inst.
Individual interest groups unable to affect trade policy
Consumer groups inactive
Universalistic logroll (?)
Cross sector coalitions (logrolling) or coalitions with labor
Consumer groups active
Factor Specific &
Non-maj. Inst.
Standard trade policy
Model (Pareto,Olson, etc)
Lobbying for protection
Cross sector coalitions (logrolling) or coalitions with labor possible, but not necessary for victory ?

64. Universalistic logroll example
Farm bill
Traditionally includes subsidies for virtually all farmers (rural interests) and food stamps for low-income workers (urban interests)
July, 2013:
Republicans in House passed farm bill with farm subsidies but without food stamps (many from rural districts)
Democrats uniformly opposed (many from urban districts)

65. Conclusions
Trade policy outcomes, including economic beneficiaries and political coalitions, depend upon various conditions, including factor mobility, political institutions, and collective action costs
Solving collective action problems (for larger groups) and majoritarian political institutions increase the likelihood of policies that benefit the majority of the population