Essays on the Political Economy of Trade Policy and Trade Agreements

Abstract

The first two chapters of this dissertation study the impact of the design of GATT/WTO trade agreements on the organization of domestic interest groups and explain several relevant empirical puzzles. Chapter 1 posits a model of trade policy formation, featuring endogenous firm participation in competing lobbies, and show that weak tariff bindings, as mandated by the GATT/WTO, serve to increase participation in the domestic pro-trade lobby and decrease applied tariffs. In the model the tariff ceiling works as an external constraint that reduces the off-the-equilibrium-path joint payoff of the government and the anti-trade lobby, thus reducing the contribution necessary for the pro-trade lobby to achieve a given applied tariff and thereby encouraging greater participation. The model explains the empirical puzzle, especially in small developing countries, that tariff caps even strictly above the applied tariffs tend to reduce the latter. We then extend the model to show that when a small country enters the negotiations towards a trade agreement, the pro-trade lobby group expands; and when the tariff cap stipulated by the trade agreement is imposed, the pro-trade lobby group expands further. Chapter 2 extends the model in the previous chapter to a setting with large countries. In the model countries can negotiate over a tariff cap that indirectly results in a desired level of applied tariff lower than the cap, and thereby eliminate the terms-of-trade externality with a positive "binding overhang". Furthermore, larger countries have lower binding overhangs. The model reconciles the discrepancy between the central role terms-of-trade motives should have played in designing GATT/WTO trade agreements and the implication of previous models that countries set unilateral optimal tariffs when the applied tariffs fall below the bound tariffs.

The third chapter of this dissertation builds the firm selection channel in Melitz (2003) into the "protection for sale" model and yields novel predictions on the relationship between a sector's degree of firm heterogeneity and level of trade protection. We assume heterogeneous firms lobby the government for protection in the unilateral setting (as well as liberalization in the cooperative setting). A lower domestic tariff imposed on a sector will raise prices of the imported varieties and drive out relatively weaker foreign exporting firms, but will allow some less productive (and thus smaller) domestic ones to survive. In each sector, lobbying activities are (endogenously) dominated by larger firms that face the trade-off between driving out weaker foreign competitors (with a higher tariff) and weeding out less efficient domestic competitors (with a lower tariff). We are able to derive explicit formulas for the protection structures across different sectors, in both the unilateral and the cooperative setting. In particular, we link the "curvatures" of the productivity distributions of both domestic and foreign firms in a sector to the sector's endogenous tariff level. We find that how a sector's domestic firm heterogeneity impacts its protection level depends on whether the political economy consideration is dominant, and that how a sector's foreign firm heterogeneity affects its protection level hinges on whether the home government sets tariffs unilaterally or cooperatively.