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Political economy of trade liberalisation: multilateral, bilateral and unilateral

Political economy of trade liberalisation: multilateral, bilateral and unilateral. Richard E. Baldwin Professor of International Economics Graduate Institute, Geneva. Political economy of trade liberalisation. 3 mechanisms: MTN, RTA, Unilateral.

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Political economy of trade liberalisation: multilateral, bilateral and unilateral

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  1. Political economy of trade liberalisation: multilateral, bilateral and unilateral Richard E. Baldwin Professor of International Economics Graduate Institute, Geneva

  2. Political economy of trade liberalisation • 3 mechanisms: MTN, RTA, Unilateral. • Key logic: Liberalisation begets liberalisation.

  3. Political Economy • Status quo tariff. • Tariff balances supply & demand for protection. • Supply = marginal cost curve (marginal welfare damage). • Demand = marginal utility curve (marginal benefit to special interests).

  4. Protection demand = benefit to domestic special interests (import competitors) euros S Sdom euros Protection demand P’ a P P’ a P T T’ Pw Ddom T T’ T quantity

  5. Protection supply = damage to domestic welfare euros S euros b d P’ c Naïve opt’l tariff a Protection Supply P T’ e f Pw g Pw’ D T quantity T’

  6. Static Political Economy euros Protection Supply (unil.) Protection demand T T • Summary • Unilaterally politically optimal tariff balances supply & demand for protection. • Supply = marginal cost curve (marginal welfare damage). • Demand = marginal utility curve (marginal benefit to special interests).

  7. Political economy of trade liberalisation • 3 mechanisms: MTN, RTA, Unilateral. • Key logic: Liberalisation begets liberalisation. • Liberalisation paradox (assuming endogenous policy choices): • Why would a govt find it politically optimal to remove a trade barrier that it previously found optimal to impose? • Must focus on the changed circumstance between the two decisions.

  8. MTNs: Juggernaut: demi-cycle 1 Starting from high 1930s tariffs … Reciprocal trade talks re-align political economy forces inside each participating nation. Example: MTN with & without reciprocity MTN makes exporters into anti-protectionists. One-off tariff cut become politically optimal in all nations that play reciprocally. Gov’t find it politically optimal to remove a tariff they previous found politically optimal to impose.

  9. Juggernaut: demi-cycle 1 Political equilibrium tariff balances S & D for protection. Reciprocal trade talks re-align political economy forces inside each participating nation. Protection supply shifts up. Exporters become anti-protectionists. euros Protection Supply (recip.) Protection Supply (unil.) Protection demand T T T’

  10. Juggernaut: demi-cycle 2 = restructuring of import competing industry & export industry Politically optimal tariff depends of size of import competing sector. Perfect comp., free entry no. of firms. Number of import competing firms rise with tariff. Basic “SR vs LR supply curve” economics price Short run Supply Long run supply P’ Po Q Q’[n’] Qo[no]

  11. Juggernaut: demi-cycle 2 = restructuring of import competing industry & export industry Translate the free entry of firms in reponse to tariff FE curve. Same for export sector, but can’t plot. Better foreign market access produces more exports and more exporting firms. Tariff -> industry size Tariff,T FE To n no

  12. Fold supply & demand into GFOC (Solution to govt pol.ec. opt’zation). euros Tariff,T NB: industry size => Tariff Protection Supply (unil.) GFOC (unil) Protection demand (no) To T’ Protection demand (n’) n T To n’ T’ no Intuitively: GFOC rises with n since politically optimal T rises with n. More to protect on margin.

  13. Equilibrium tariffs and industry size . Tariff -> industry size Tariff,T FE Eo To GFOC (unil) Tariff <- industry size n no

  14. Juggernaut effect Start: unilaterally politically optimal tariff, To. Reciprocal trade talks shift GFOC down. Lower opt’l T for any given n (exporters are now in the game). Recall shift in protection S&D diagram Tariff,T FE GFOC (unil) Eo To GFOC (recip) n

  15. Juggernaut effect Immediate cut in MTN to T1 But this is not the end point. Juggernaut rolls forward. The lower tariffs alters the political economy landscape in every participating nation. no falls to n1 Next MTN, Tariff is cut even more Until new equilibrium T’. Tariff,T FE GFOC (unil) Eo To A GFOC (recip) T1 B T’ E’ n n1 no

  16. Juggernaut effect If all exports covered by the reciprocity, politically optimal tariff is zero. Could take decades downsize the anti-trade forces (import competing firms) & build pro-trade forces (export firms). Tariff,T FE GFOC (unil) Eo To GFOC (MTN) n Efinal

  17. Domino effect Demi-cycle I: Idiosyncratic formation or deepening of a trade bloc re-aligns the political economy forces inside non-member nations. Pro-membership political economy forces: Non-member exporters: Trade diversion (fresh loses) & Trade Creation (lost opportunity). Anti-membership political economy forces: If deeper, may resist more. If export sectors are politically larger than import competing sectors. Demi-cycle II: if a new member joins, “forces for inclusion” get stronger in non-member nations.

  18. Domino theory of regionalism • Equilibrium block size • The nations ordered by intrinsic resistance to membership • RR curve • RR curve intersects the x-axis; assuming membership is viewed as having non-economic benefit in some nations • (these nations would join even if there were a mild political economic cost to doing so.) dollars RR EE E o number of bloc members

  19. Domino theory of regionalism • Exporters located in non-members see more trade discrimination as bloc size rises. • (& lost-opportunity trade creation) • Rising EE curve. dollars RR EE E o number of bloc members

  20. Domino theory of regionalism • Idiosyncratic shock moves EE to EE’ • e.g. deeper integration among same members, • New nations “join the RTA game” • Move to E’, but may happen in step wise fashion as membership triggers more membership.

  21. R.T.B. unilateralism Competition for out-sourcing jobs and investment drive nations to unilaterally cut tariffs. Re-aligns political economy forces in DCs. Unbundling of manufacturing process (i.e. fragmentation, vertical differentiation, slicing up value added chain) is key. Destroys import substitution (scale, competition) Makes export-led industrialisation more successful (foreign technology from MNC/buyers, ready market). Finer division of labour may mean no import competing industry. MNC role may imply imports mostly re-exported. Importers are also exporters => no political economy conflict.

  22. Ancillary effects Intra-sectoral special interest politics. Melitz model & reciprocal liberalisation: big firms win, small firms lose. Add Mancur Olsen’s Asymmetry on political organisation & juggernaut effect works well on intra-industry trade. “Losers lobby harder” (NIMBY syndrome). Home market magnification effect. Industry becomes more footloose, not less, as trade barriers fall. Competition for industry becomes more fierce as tariffs fall globally. (Small preference margins can matter a lot).

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