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

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

Supply and Demand Model

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

Demand curve Price 5 3 D 1 Quantity 1 2 3

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

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

(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)

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

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

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

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

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

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)

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)

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

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

Organizing Interests: The Collective Action Problem and Trade Policy Demands

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

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

http://www.youtube.com/watch?v=Ro_-isihnqM

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

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?

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

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

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

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

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 $0.5-1.5 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

http://www.theguardian.com/cartoons/stevebell/0,7371,1100627,00.html

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)

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

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

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

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

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

“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

“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)

“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

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

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

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

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

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

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

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

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

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?)

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

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

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?

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?

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

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

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)

Jose & Alfonso Fanjul of Florida Crystals

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

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…

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

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

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

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

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

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 ?

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)

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