Introduction - University of Michigan

Chapter 10. Arguments for and against protectionism
Jobs, Jobs, Jobs
Data relating to Mfg. & Automotive Sector
Theory of Second Best
Specificity Rule
Infant Industry
Politics of Protectionism
Political Economy of Voting
Link to syllabus
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
Non-farm Employment, 2007; 000s
Non-Gov't Service
Trade, Transport, Utilities
Business Services
Education & Health
Leisure & Hospitality
Goods Producing
Nat'l Resource & Mining
Employment in the US. Private, Service-Providing
Employment in the US. All Governments
Employment in the US. Manufacturing, 1,000s
US Transportation Equipment
Employment, in thousands
Michigan Total Manufacturing
Michigan Transportation Equipment
BLS data
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)
Ultimate data source is Institute for International Economics
(More elaborate data on next slides)
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.
Bend one rule, you might have to bend others, as well.
Example: standing to reach the highest point on the side of a hill.
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.
Our application is to free trade in a competitive environment.
Specificity rule (p. 204)
It is usually more efficient to use the government policy tool that acts
as directly as possible on the source of the distortion separating private
and social benefits or costs.
Although a barrier against imports can be better than doing nothing in
a 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 than
a tariff, because it doesn’t distort prices for consumer.
Figure 10.2 page 206 Two ways to promote importcompeting 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 Summary
General 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 problem
An 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
• 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?
Application of Voting Models to the analysis of trade policy.
"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’
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.
Voting models, continued
“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 importanc
of short term macro factors such as unemployment and inflation.
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
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
Size of change of income (total, or per person) depends on:
- Specificity of policy (titanium or tobacco, vs. “food" or
- 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 Conclusions
1) 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
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
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 WWII
1. 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 sector
4. 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 GATT
1974 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. If
political decisions in a small country were based on this metric, what
sort of protectionism would the country have?
Question #1 p. 227
A Single firm’s innovations in production technology often benefit
the production of other firms, because these other firms learn about the
new technology and can use it
a) 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 production
c) What third policy (a tax or subsidy or something) would the economis
recommend as even better?
October 28, 2006 NYT Democrats Get Late Donations
From Business
— 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
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.
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
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.

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