The Political Economy of Trade Policy (Part 1)

Writing at EconLog, Scott Sumner makes the following point in his excellent blog post entitled “Keynesian Fiscal Policy is Dead“:

Many non-economists do not understand fiscal policy; they view it as something that can be applied on a sort of ad hoc basis. But things don’t work that way, as Keynesian fiscal policy requires a countercyclical (full employment) budget deficit.  It’s a full-fledged policy regime that must be maintained over time, not a gesture to be employed at a point in time.  You can’t say “let’s do fiscal policy this year”.

Scott’s point can be expanded to include trade policy as well.  Trade policy is, likewise, not something that can be applied on an ad hoc basis.  Consistent and predictable rules are necessary to maintain trade.  What’s more, theoretical economic trade management (eg, an optimal tariff) requires an extreme level of precision and consistency.

But can we assume such consistency in policy?  I think not, especially in a democracy/republic.  If one of the parties does not buy into said policy regime, then maintaining it is virtually impossible, unless that party is deliberately kept out of office.  Or, if the two parties have differing points of view on the goal of trade policy.  If one group wants an optimal tariff and the other wants tariffs to match international taxation regimes (both, in theory, legitimate tariff goals), those two policies will be at odds with one another.  How the regime is established will depend on who is in power at any given time.

How likely is it, even with the same party in power, that the policy remains consistent?  That is not so clear.  Politicians, especially in a system where they face voter pressure, are subject to various whims; as Adam Smith puts it: “[statesmen] whose councils are directed by the momentary fluctuations of affairs (WN 468).”  Even if we assume consistency in policial parties, inconsistency in various affairs should give us pause when assuming consistency over time in policy goals.

But, even if we assume consistency in policy goal over time, we run into the issue of policy adjustment.  For example, an optimal tariff depends on how sensitive domestic consumers are to changes in price; if they are highly sensitive, then an optimal tariff would be extremely low.  If they are not very sensitive, then an optimal tariff could be relatively high.  But, this sensitivity adjusts over time (Second Law of Demand).  This would mean that the optimal tariff level would need to be adjusted periodically (ideally, constantly) to compensate for this changing sensitivity.

However, firms and individuals adjust to policies.  With any policy, we run into Gordon Tullock’s transitional gains trap.  Firms and individuals will fully capitalize the monopoly gains they get from policy protections, leading them to do no better than before the policy was initiated.  What this also means is that if the policy were to be changed or removed, these firms/individuals would face the potential for major losses.  It would be strongly in their interests to keep the policy from changing.  Furthermore, since these losses to the entrenched firms/individuals would be highly visible and concentrated, but the benefits dispersed among the entire society, it would be a relatively easy pitch for these entrenched interests to keep the policy in place.

Another point worth quickly mentioning in relation to the previous paragraph: most trade policy models assume no resources spent on lobbying.  If we relax that assumption and assume that firms/individuals do indeed lobby, either for or against various trade policies, then any potential gains from these policies are quickly eaten up in the costs of lobbying.  Further, because of the aforementioned dispersed costs and concentrated benefits, the entrenched interests would be willing to spend more on lobbying than the people harmed by the policy,* which could potentially cannibalize all potential gains from the policy and then some.

*This point may require some explanation.  Assume a society of 10 individuals.  A policy is proposed that could improve the wellbeing of one member by $200, but only through the cost of the rest of society by $300 (or $33.33 per person).  Therefore, the one member would be willing to spend up to $200 to lobby for this policy, but each individual may only be willing to spend up $33.33 to lobby against.

Today’s Quote of the Day…

…is from Adam Smith’s 1783 letter to William Eden, Lord Auckland, to which Prof. Smith responded to a question on whether or not England should have preferential and different duties on other nations (page 271-272 of the Liberty Fund’s Correspondence of Adam Smith):

I shall only say at present that every extraordinary encouragement or discouragement that is given to the trade of any country more than to that of another may, I think, be demonstrated to be in every case a complete piece of dupery, by which the interest of the State and the nation is constantly sacraficed to that of some particular class of traders.

JMM: Indeed so.  As I wrote before, when there is ambiguity of purpose, when multiple excuses may be given for various government handouts, we must expect that there is going to be abuse and “dupery” and firms and individuals vie for such handouts.