Political Geography and the Trade Restriction Bias Lucy Goodhart

An Enduring Puzzle “A second question left unanswered by the literature is why import-competing groups on average seem to win out in net against exporting groups. …There exist few countries in the world in which the net effect of trade policies is not to repress trade…Why do we not see more countries in which export (or import) subsidies dominate?” Alt et al, What’s the evidence for a bias against export subsidies (and import subsidies) and towards import tariffs? Look at almost any of issue of the Trade Policy Review for a particular country.

The Challenge to Existing Theory Effect of international regimes: Export subsidies illegal under GATT and WTO. As Rodrik (1995) notes, however, regulation is endogenous and has also been ineffective on quantitative restrictions. Industry characteristics or Demand Side (Interest Groups): The industry that can lobby for tariffs in one country is the same industry that somehow cannot lobby for export subsidies in another country. Fiscal Implications and the Supply Side: Why should the fiscal constraint still bite? If it does, why has the U.S. awarded significant tax benefits to exporters via FSC categorization.

Model: Policy Choice by a Localized Representative Model of localized re-election incentives from local growth for representative in district I. Utility is positively related to output in district but is negative in policy effort. The representative supplies policy effort on behalf of one industry or firm before hitting strict contraints on legislative inputs. Utility function does not take into account the marginal effect on input costs or the losses in consumer surplus from trade policy.

Two Stage Optimization Process Representative first calculates the optimal level of trade policy to supply for each industry in district and then compares net benefits across industries. First Stage: Set Problem: Trade Policy may cause a firm or industry to expand outside the district if they are near the point of output at which they would invest in another plant.

Lumpiness in Output and Trade Policy Firms expand along their short-run average cost curve until they get to the point at which they are better-off investing in new plant. If you invest in new plant, you are likely to invest in another location. The representative assumes that you stay in district with probability. The zero weight given to output elsewhere sets up a wedge in the treatment of firms depending on where the firm is relative to the “reinvestment point”. Firms that have recently grown, and are near this point, offer lower marginal benefits to the representative from trade policy. The highest total net benefits to the representative come from firms that have previously lowered their output level (and or employment) because they have excess capacity available for expansion in district.

Why are Export Firms more likely to be Growing than Import-Competing Firms Product Cycle Theory: Vernon (1966), trade adjusts to continuous technology shocks and gradual diffusion of technology. Comparative Advantage with Changing Endowments or Trade Costs: The economy moves towards the sector of comparative advantage. Empirical Evidence: Bernard, Jensen and Schott (many years), Exporting firms grow to become exporters and expand employment more than non-exporters. Firms competing against low-wage imports are more likely to lower employment, decrease output and close.

Discussion As in Shepsle, Weingast and Johnson (1981), trade policy benefits are over-supplied because representatives do not internalize dispersed consumer losses. Localized representatives privilege expanded production in district because they have invested in a local reputation. Model abstracts from the end stage of policy-making at national level but this does not affect the bias in the representative’s screening process against export producers. Model can travel to PR systems so long as some politicians or parties build a reputation in a given locality.

Conclusions Local representatives offer trade policy benefits to firms that have declined because they offer the greatest potential expansion in district. Export firms are more likely to be growing and import- competing firms shrinking, explaining the observed bias in the provision of trade policy benefits to import-competitors. The model also explains the targeting of trade policy benefits via tariffs to declining industries and those that have seen greater import penetration (Marvel and Ray, Ray). Finally model explains the strange provision of export subsidies to farmers (they can’t move!).