The Politics of Trade

Society-Centered Approach to Trade Politics

A society-centered approach to trade politics asserts that government trade policy objectives are influenced by the responses of politicians to the demands of interest groups or societies. For instance, the European Union’s reluctance to liberalize European agriculture reflects policymakers’ responses to the demands of European farmers. This approach highlights the interplay between organized interests and political institutions, recognizing the distributional consequences of trade and how winners and losers engage in political competition to advance their economic interests.

Trade policy preferences are further explored through two models: the Factor Model and the Sector Model. The Factor Model contends that trade politics are driven by the competition between factors of production, such as labor and capital, resulting in distinct trade policy preferences. On the other hand, the Sector Model argues that trade divides society along industry lines due to differing assumptions about factor mobility. Both models agree that trade policy preferences hinge on the income consequences of trade, with winners advocating trade liberalization and losers favoring protectionism.

Factor Model

The Factor Model of society-centered trade politics asserts that trade policy preferences are driven by competition between factors of production, such as labor and capital. This results in distinct policy preferences based on whether one benefits from trade or not.

The Factor Model posits that owners of abundant factors will advocate for free trade, as they stand to gain from greater access to overseas markets that lack this abundant factor. For example, capital owners in capital-abundant countries will favor free trade to maximize returns on their capital by expanding to labor-abundant markets overseas.

In contrast, owners of scarce factors will resist free trade as it leads to greater competition from overseas factors of production. For instance, labor groups in capital-abundant countries are more likely to advocate for protectionist policies that shield their jobs and wages from competition with cheap labor from capital-scarce countries.

The Factor Model contends that by dividing society along factor ownership lines, international trade inevitably creates distributional consequences as abundant and scarce factors are affected differently. This pitting of labor against capital interests then shapes distinct trade policy preferences and fuels the ensuing political competition between the two groups. Fundamentally, the model argues that income effects from trade determine attitudes towards trade liberalization or protectionism.

Sector Model

The Sector Model asserts that trade policy debates divide societies along industry lines rather than between factors of production like labor and capital. This model posits that factors of production are mobile between industries within a country but not necessarily between countries. As a result, trade affects industries in different ways based on their factor intensity, creating distinct trade policy preferences across industrial sectors.

For example, capital-intensive industries like chemicals and machinery favor free trade policies since they rely predominantly on capital. In contrast, labor-intensive industries like apparel and agriculture prefer protectionist policies since imports compete directly with domestic labor. Because factors cannot easily move between industries, the income effects of trade are felt at the industry level. Thus, each industry adopts trade policy preferences according to its factor input requirements.

The Sector Model holds that factor immobility between industries causes trade to have uneven effects. Consequently, trade divides society along sectoral lines as industries jockey politically to advance their interests through trade policy. This demonstrates how distributional conflicts occur not only between factors but also across industries. Overall, the interaction between trade’s disparate effects and political mobilization of sectoral interests helps explain trade policy outcomes.

State-Centered Approach to Trade Politics

The state-centered approach posits that national policymakers intervene in the economy independently of narrow, self-interested concerns of domestic interest groups. The intervention is seen as potentially raising aggregate social welfare. Governments may employ tariffs, production subsidies, and other instruments to enhance aggregate social welfare.

This approach is grounded in two key assumptions. First, policymakers assume that protectionism can positively impact aggregate social welfare under certain conditions. Second, governments believe they can act with autonomy from interest group pressures in select circumstances. In essence, the state-centered view asserts that governments do not solely respond to the demands of organized domestic interests when formulating trade policy.

Rather, policymakers make independent judgments about the national interest and the potential for protectionism to achieve social objectives. Whether enhancing infant industries, supporting high-technology sectors, or promoting other development goals, governments embrace a wider conception of trade policy not limited to placating interest groups. The state-centered approach recognizes the state’s distinct capacity to shape trade regimes based on a broader notion of the public good.

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Infant Industry Protection

The infant-industry case for protection argues that newly created firms may not initially be efficient, but could mature into competitive enterprises if given short-term protection from international competition. The idea is that fledgling domestic industries need time to develop economies of scale and gain experience in order to become efficient and competitive in the long run.

Temporary trade barriers like tariffs or import quotas can shield infant industries from being overwhelmed by established foreign producers. This allows domestic firms to invest in the latest technologies and business processes, build market share, train workers, and move down the cost curve through accumulating production experience. As firms become more productive and efficient, tariffs can be gradually phased out.

However, infant industry protection should not become permanent, as that could lead to uncompetitive and stagnant industries reliant on government support. The protection period should be limited to the shortest time necessary for firms to reasonably attain international competitiveness. Governments must credibly commit to removing protections after an industry matures. Effective infant industry policies also require picking industries with real prospects for competitiveness and facilitating access to investments in physical and human capital.

Industrial Policy

Industrial policy refers to government intervention in the economy designed to strengthen domestic firms and enhance their international competitiveness in strategic or high-technology industries. Under industrial policy, governments provide subsidies, tax incentives, low-interest loans, and other support to domestic companies in order to help them achieve scale, increase productivity, and develop innovative technologies.

The rationale behind industrial policy is that high-technology industries often exhibit increasing returns to scale and learning effects. This means that as firms gain experience and expand production, their productivity and efficiency tend to rise substantially. In addition, many high-technology sectors are characterized by oligopolistic market structures - dominated by just a few large firms. As a result, there may be a role for government to help nurture domestic firms, through temporary support, so they can achieve competitiveness against established foreign rivals. Strategic trade theory provides an economic justification, suggesting government intervention can raise economic welfare in these types of imperfectly competitive global industries.

By promoting national champions and supporting strategic sectors, industrial policy aims to enable domestic firms to earn economic rents and thrive in global export markets. This is viewed as more beneficial than relying entirely on free market forces. Successful industrial policies have been credited for the rise of South Korean and Japanese electronics and auto companies. However, designing effective industrial policies can prove challenging for governments, requiring flexible approaches that avoid potential market distortions.

Strategic Trade Theory Supports State Intervention

Strategic trade theory provides theoretical justification for state intervention in trade policy, particularly in high-technology industries which tend to have an oligopolistic market structure. This theory argues that in oligopolistic markets with significant barriers to entry and economies of scale, the optimal market outcome may not emerge naturally.

Governments can potentially use trade policy tools like tariffs, subsidies, and quotas to help domestic firms gain international competitiveness and earn economic rents in these strategic industries. By supporting national champion firms, governments aim to shift profits and benefits away from foreign oligopolists and capture a greater share of economic gains for domestic producers.

For example, strategic export subsidies could allow domestic firms to expand production, move down the cost curve, and improve their competitiveness through economies of scale. Or import tariffs could be used to protect fledgling domestic industries from established foreign competitors. Strategic trade theory provides an economic rationale for these activist industrial policies as a means of promoting national competitiveness and efficiency in oligopolistic high-technology sectors.

Trade Liberalization

A key concept for understanding the formation of trade policy preferences is trade liberalization. Trade liberalization refers to efforts that allow greater freedom and choice in markets through lowering barriers to trade. This includes reducing or eliminating tariffs, quotas, and other restrictions on the flow of goods and services between countries.

The society-centered and state-centered approaches recognize that trade liberalization creates both winners and losers within an economy. According to these perspectives, those that stand to benefit economically from more open trade will advocate for reducing trade barriers. These winners include consumers who gain access to cheaper imports and companies that expand their exports.

On the other hand, groups that face greater competition from abroad due to trade liberalization will favor protectionism and erecting trade barriers. These losers may include domestic companies and industries that compete directly with foreign imports. Workers in import-competing sectors may also push for protectionist policies to shield their jobs and wages from foreign competition.

The key insight is that an individual, company or industry’s position on trade liberalization depends greatly on the income consequences. Potential winners will pressure policymakers to open markets, facilitate free trade and enact trade agreements. Meanwhile, prospective losers will lobby for protectionist measures such as tariffs and non-tariff barriers to shelter them from the full brunt of foreign competition.

Distributional Consequences

Trade policy has uneven economic impacts across society, inevitably creating winners and losers. While trade liberalization generally improves overall welfare, the benefits are not distributed equally. Certain industries, firms, and workers can face significant disruption and displacement from import competition and changing terms of trade. The distributional consequences of trade arise from various factors:

• Comparative advantage - Countries specialize based on relative factor endowments, such as skilled labor or capital. As production shifts towards industries where a country has a comparative advantage, there are accompanying employment effects. Workers in declining industries bear the costs of adjustment and may lack the skills to transition easily to growing sectors.
• Differences in productivity - More productive firms are better positioned to take advantage of trade opportunities, putting pressure on less competitive firms which are more exposed to import competition. These dynamics can accelerate industrial concentration.
• Location effects - The geographic concentration of industries means that certain regions disproportionately feel the effects of trade adjustment, whether positive or negative. This geographic inequality can spur political divisions.
• Labor immobility - Workers impacted by trade liberalization often face high costs of relocating or transitioning between industries or occupations. This labor immobility allows negative effects to persist.
• Income inequality - By benefiting capital and highly skilled labor over less-skilled workers, trade can contribute to income inequality within countries. The costs fall heavily on less-educated, blue collar workers.

In response to these uneven impacts, affected groups mobilize politically in protectionist and compensatory directions to mitigate harms and bargain for government support. Consequently, trade policy cannot be separated from equity concerns and demands for adjustment assistance. Governments seeking to liberalize trade must balance aggregate economic gains against harsh transitional consequences for vulnerable groups.

Interest Group Engagement

The society-centered approach underscores the political interplay between organized interests and political institutions. Special interest groups such as labor unions, trade associations, and other membership organizations have a major stake in trade policy outcomes. As trade creates winners and losers, these groups engage in political mobilization and competition to advance their economic interests.

Politicians, in turn, respond to the demands of these competing groups in an effort to maximize political support. Interest groups that stand to benefit from trade liberalization will pressure policymakers to lower trade barriers and expand market access. Groups that risk losing from greater foreign competition will push for import restrictions and other protectionist measures. The policy preferences and relative influence of domestic interest groups are thus critical in shaping government trade policy.

Through lobbying, campaign contributions, and grassroots advocacy, interest groups leverage their political power to meet their goals. They galvanize member participation, cultivate relationships with sympathetic legislators, and seek direct meetings with key officials to make their voices heard. Groups threatened by liberalization often defend the status quo by emphasizing trade’s distributional consequences and the plight of affected industries. This complex interplay between societal interests and the political system drives the direction of trade policy in democracies.