Academic journal article Federal Reserve Bank of St. Louis Review

Political Economy Determinants of Non-Agricultural Trade Policy

Academic journal article Federal Reserve Bank of St. Louis Review

Political Economy Determinants of Non-Agricultural Trade Policy

Article excerpt

The authors investigate several existing political economy hypotheses on trade policy using cross-country trade-protection data for non-agricultural goods. The authors find that a left-leaning political regime leads to pro-labor trade policies only for a subset of trade policy measures. In addition, they find that income inequality and country-level corruption appear to be important determinants of trade policy. For various measures of trade protection, it appears that corruption tends to hurt labor interests by increasing trade protection in labor-abundant countries and reducing trade protection in capital-abundant countries. This finding suggests that corruption, among other factors, may move trade policy away from the desires of the median voter. (JEL F10, F11, F13, D73)

Federal Reserve Bank of St. Louis Review, March/April 2011, 93(2), pp. 89-104.

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Trade policy is often used by policymakers to favor certain constituencies. Tariffs and non-tariff barriers lead to increases in the price of the goods produced by import-competing sectors. Consequently, incomes of some factors of production in these sectors often rise at the expense of other factors. The theoretical foundations of this idea come from the famous Stolper-Samuelson theorem, which shows that protection raises the real return of the factor used intensively by the import-competing sector, while reducing the real return of the factor used intensively by the export sector. This result along with the Heckscher-Ohlin theorem on trade patterns suggest that, for a given country, greater protectionism causes hardships for its abundant factor but benefits its scarce factor. Thus, protectionism causes labor to lose in labor-abundant countries but gain in capital-abundant countries.

Consequently, if capital ownership is concentrated in the hands of a few in both labor- and capital-abundant countries, then the median voter in both countries will be a laborer. Majority voting will favor trade liberalization (or free trade) in labor-abundant countries but protectionism in capital-abundant ones (where labor loses from trade).The greater the income inequality in a country, the more pronounced this effect is likely to be. Therefore, one can expect inequality to reduce trade protection in labor-abundant countries, while raising it in capital-abundant ones.

The motive for appeasing the majority may be reinforced or neutralized by the political ideology of the government. For example, an increase in the leftist orientation of a government may lead to an increase in the weight attached to labor welfare relative to capital welfare in the government's weighted objective function. This will result in trade policies that are more pro-labor and complementary to the median-voter effect discussed above.

Dutt and Mitra (2002, 2005) provide evidence in support of both the inequality and political ideology hypotheses, respectively. Using a framework similar to the Heckscher-Ohlin Stolper-Samuelson framework, Djerdijan (2007) studies the simultaneous interaction of inequality and political ideology on trade policy. He finds that an increase in income inequality in a pro-worker regime is associated with more equitable trade policies, while in a pro-capitalist regime it is associated with more inequitable trade policies.

Our paper adds to the existing literature in the following ways. First, unlike the existing literature on cross-country trade policy, we use trade-protection data for the non-agricultural sector instead of aggregate trade data. We do this because, while the non-agricultural sector (e.g., mining and manufacturing) can be categorized as either labor intensive or capital intensive, it is difficult to ignore land as a third factor of production for the agricultural sector. Therefore, given that a prime motivation of this study is to understand how trade policy affects income distribution between labor and capital, using non-agricultural trade-protection data is more appropriate than using aggregate trade data. …

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