Endogenous Trade Policies in a Developing Economy

This paper examines the formation of trade policy for a small open developing economy where lobbying activities may be carried out to influence policy‐making decisions. The paper presents a three‐sector economy in which the manufacturing sector can lobby policymakers for favorable policies. Under some plausible conditions, it is demonstrated that lobbying activities carried out by the owners of the specific factor in the manufacturing sector would secure a protectionist trade policy through either an import tariff or an export subsidy. The government also imposes a consumption tax on agricultural products, which further strengthens the protectionist measure applied to the manufacturing sector. In general equilibrium, there will be a movement of labor to the manufacturing sector, an output expansion in the manufacturing sector, and an output contraction in the agricultural sector, exactly as suggested by factual evidence.