Cross‐border Lobbying in Preferential Trading Agreements: Implications for External Tariffs and Welfare

This paper examines the effect of cross‐border lobbying on domestic lobbying and on external tariffs in both Customs Union (CU) and Free Trade Area (FTA). We do so by developing a two‐stage game which endogenizes the tariff formation function in a political economic model of the directly unproductive rent‐seeking activities type. We find that cross‐border lobbying un‐ambiguously increases both domestic lobbying and the equilibrium common external tariffs in a CU. The same result also holds for FTA provided tariffs for the member governments are strategic complements. We also develop a specific oligopolistic model of FTA and show that tariffs are indeed strategic complements in such a model.     

Welfare Effects of Tariff Reduction Formulas

World Trade Organization (WTO) negotiations rely on tariff reduction formulas. Formula approaches are of increasing importance in trade talks, because of the large number of countries involved, the wider dispersion in initial tariffs (e.g. tariff peaks), and gaps between bound and applied tariff rates. This paper presents a two country intra‐industry trade model with heterogeneous firms subject to high and low tariffs. We examine the welfare effects of applying three different tariff reduction formulas discussed in the literature that were used and proposed in previous and current General Agreement on Tariffs and Trade (GATT)/WTO negotiations (1) a proportional cut, (2) the Swiss formula and (3) a tiered formula. No single formula dominates for all conditions. The ranking of the three tools depends on the degree of product differentiation in the industry and the achieved reduction in the average tariff.     

The effect of the Canada‐US Free Trade Agreement on Canadian multilateral trade liberalization

In this paper show that the Canada‐US Free Trade Agreement (CUSFTA) tariff preferences have triggered a decline in Canadian external tariffs, explaining a two percentage point reduction in the average tariff between 1989 and 1998. Next, we found that industries that generate the least export rent to the US firms experienced deeper tariff cuts in Canada; this result provides evidence of cooperation in trade policies between the US and Canada. Finally, we estimate the effect of the CUSFTA on the intensity of industrial lobbying for trade policy in Canada and find no relationship between preferential trade liberalization and lobbying activity.     

POLITICAL ASYMMETRY AND COMMON EXTERNAL TARIFFS IN A CUSTOMS UNION

This paper examines the effect of political and economic asymmetries in the formation of common external tariffs (CETs) in a customs union (CU). We do so by introducing possible cross‐border lobbying and by endogenizing tariff formation in a political economic model for the determination of CETs. The latter allows us to consider asymmetries among the member nations in their susceptibilities to lobbying. We also consider asymmetries in the influence of the member nations in CU‐wide decision‐making. A central finding of this paper is that, in the absence of economic asymmetry, the CET rises monotonically with the degree of asymmetry in country influences if the two countries are equally susceptible to lobbying. If influences are the same, the CET also rises monotonically with the degree of asymmetry in susceptibilities. These results hold irrespective of whether the lobby groups in the two member countries cooperate or work non‐cooperatively.     

Regional Trade Agreements and Cross‐border Lobbying: Empirical Evidence from the Canada–US Free Trade Agreement Negotiations

This paper documents participation of special interest groups in negotiations of the Canada–US Free Trade Agreement. Using data on the tariff reduction schedules mandated by the agreement, it shows that industries represented by strong lobby groups were faced with more favorable tariff reduction paths in both countries: phase‐out periods were longer at home and shorter in the partner country. This result provides evidence on the involvement of industry lobbying in negotiation of regional trade agreements and suggests that countries negotiating trade agreements are responsive to the interests of lobbying groups from across the border. Both results provide important implications for the political economy theory of trade agreements.     

Reconciling Observed Tariffs and the Median Voter Model

Median voter theory applied to trade policy predicts positive tariffs in capital‐abundant countries and negative tariffs in labor‐abundant countries. Negative tariffs are rare, and this paper reconciles the median voter theory with observed protectionism across countries. By considering large countries, I show the optimal tariff is a sum of the median voter component and a positive term of trade component. Positive terms of trade effects raise tariffs in all countries, and can overcome the negative median voter component in labor‐abundant countries. Testing the tariff prediction with cross‐section and panel data from the 1990s, I show the median voter component is negative in labor‐abundant countries and positive in capital‐abundant countries. As expected, terms of trade effects raise tariffs across all countries and are stronger among nonmembers of the WTO.     

Endogenous Free Trade Agreements and Foreign Lobbying

This paper assesses the political viability of free trade agreements (FTAs) in the presence of lobbying by organized foreign interest groups. The assessment is based on a model in which external tariffs and the decision to form an FTA are endogenously determined. The findings demonstrate that, in the presence of an organized lobby group in a prospective partner country, an FTA may initiate an increase in the level of protection against imports from third countries and impede trade with non‐member countries. Further, this study finds that a foreign lobby may encourage the local government to enter a welfare‐reducing trade‐diverting FTA. Finally, this paper shows that an FTA increases the lobbying power of the organized lobby groups of the member countries, which can potentially obstruct the viability of welfare‐improving multilateral trade liberalization.     

Explaining Export Performance through Inputs: Evidence from Aggregated Cross‐country Firm‐level Data

Which trade barrier related to intermediate inputs forms a greater burden on the export performance of firms in developing countries? Using aggregated cross‐country firm‐level data covering 43 mostly developing economies, this paper estimates the marginal importance of the impact of various intermediate input trade cost barriers, namely tariffs, non‐tariff barriers (NTBs) and services barriers, on firms' export behavior. In a cross‐sectoral setting, this paper takes the firm's export performance in goods as a central focus to study the effects of these different trade barriers through the exporting firm's choice of use of intermediate inputs. The results show that the most significant trade barriers on inputs that impede export performance in developing countries are mainly NTBs and restrictions of services.     

Tariff effects on MNC decisions to engage in intra-firm and arm's-length trade

Abstract .  Using confidential firm-level data from the Bureau of Economic Analysis (BEA) on activities of U.S. multinational corporations (MNCs) and their Canadian affiliates, we study the dramatic growth of intra-firm and arm's-length U.S.-Canada trade over the 198495 period. We find that decisions to engage in intra-firm and arm's-length trade are essentially unrelated to tariff and transport cost reductions over this sample period. Thus, we find that the increase in trade occurred almost entirely on the  intensive  rather than the  extensive  margin. This is consistent with case study evidence in Keane and Feinberg (2006), where MNC executives consistently indicate that the modest tariff reductions of the 198495 period were not sufficient to justify fixed costs of overhauling international supply chains. Our results have important implications for recent influential models of international trade that rely on sensitivity of intra-firm trade to tariffs at the  extensive  margin to explain how small tariff declines could have led to the explosion of intra-firm trade since the 1980s. We also find that initial conditions (i.e., 1983 tariffs) are uncorrelated with whether firms engaged in intra-firm or arm's-length trade activity at the start of the sample period. This result is surprising as it implies that firms/industries with a greater propensity to engage in trade were not, in general, successful at lobbying for more favourable tariff treatment.     

Developing-Country Benefits from MFN Relative to Regional/Bilateral Trade Arrangements

Using a general‐equilibrium model of world trade, this paper evaluates the benefits of most‐favored‐nation (MFN) treatment to developing countries in multilateral relative to bilateral or regional trade agreements, from three sources. First, developing countries may be able to free‐ride on bilateral tariff concessions exchanged between larger countries in MFN‐based GATT/WTO rounds. Second, MFN benefits developing countries by restricting discriminatory retaliatory actions by other countries, evaluated here by a non‐ cooperative Nash tariff game. Finally, MFN changes threat points in bargaining and hence affects the bargaining solution of multilateral MFN‐based trade negotiation compared to a bilateral/regional arrangement. The authors find that the benefits to developing countries are small in the first case as the tariff rates are already low, and the benefits are small in the second case as the optimal tariffs under unconstrained retaliation are not very asymmetric. Benefits from the third case are large as large countries can extract large side‐payments if they bargain bilaterally.     

Regional Blocs and Foreign Direct Investment

The paper examines the impact of the emergence of regional blocs on the patterns of interbloc and intrabloc trade when firms have the option to engage in foreign direct investment (FDI). For exogenously given external tariffs, when firms have the option to engage in FDI, all interbloc trade may cease—complete trade diversion that is replaced by interbloc FDI investment creation. In such an event the volume of world trade declines but this is more than offset by the increase in world output due to direct investment. The paper also investigates the optimal tariff that a trading bloc levies on imports from nonmember countries. The tariffs are restricted by the option to engage in two‐way direct investment; hence, the regional blocs are hampered from mutually harming one another through an escalation in the tariff war. Finally, the formation of two regional blocs enhances the welfare of all countries.     

Cost‐reducing R&D Investment,Labor Market and Trade

This paper constructs a two‐country model in which oligopolistic firms export goods and undertake cost‐reducing R&D investment. Each country imposes tariffs. A decrease in the tariff rates in both countries decreases cost‐reducing R&D investment.     

Strategic tariffs, tariff jumping, and heterogeneous firms

The majority of research to date investigating strategic tariffs in the presence of multinationals finds a knife-edge result where, in equilibrium, all foreign firms are either multinationals or exporters. Utilizing a model of heterogeneous firms, we find equilibria in which both pure exporters and multinationals coexist. We utilize this model to study the case of endogenously chosen tariffs. As is standard, Nash equilibrium tariffs are higher than the socially optimal tariffs. Unlike existing models with homogeneous firms, we find that non-cooperative tariffs promote the existence of low-productivity firms relative to the socially optimal tariffs. This highlights a new source of inefficiency from tariff competition not found in models of homogeneous firms. In addition, we find that in many cases the Nash equilibrium tariff when FDI is a potential firm structure is lower than when it is not. As a result, FDI improves welfare by mitigating tariff competition.     

Tariff Rate as a Public Good

If domestic firms lobby for protection, the tariff rate is a public good to all domestic firms, whether they engage in lobbying or not. This paper analyzes how the endogenous tariff rate as a public good depends on the group size in two‐stage lobbying models. The result depends not only on whether domestic firms lobby cooperatively or not, but also on whether domestic firms incur indirect lobbying costs or not. This paper shows that if free riding is not very serious and if the number of domestic firms is small compared to the number of foreign firms, entry of a domestic firm is likely to increase the equilibrium tariff rate.     

Tariff Liberalization and Trade Integration of Emerging Countries

This paper investigates how tariff liberalization has affected exporting at the product‐destination level in emerging countries. We use a highly disaggregated (six‐digit level of the harmonized system—HS—classification) bilateral measure of market access to compare tariffs applied in 1996 and 2006, which includes the timing of the Uruguay Round and episodes of bilateral liberalization. Our econometric estimations consider impacts of tariff cuts on three components of the trade margins: extensive margin of entry (new trade relationships at the product‐destination level), extensive margin of exit (disappearance of existing relationships) and intensive margin of trade (deepening existing relationships). Our main estimates indicate that a reduction of bilateral applied tariffs of 1 percentage point increases the extensive margin of entry by 0.1% and the intensive one by 2.09%, while it reduces the extensive margin of exit by 0.25%.     

An empirical investigation of interregional production relations and comparative advantage in US manufacturing, 1960–70

Hypothesized differences in mean changes in shares of European Community (EC) import markets over the period 1976-84 are tested for each of 36 less-developed countries. Means are calculated for cases in which MFN tariffs are re-established and for cases in which duty-free treatment is restored under the EC generalized system of preferences. They are compared with means for cases in which tariffs remained constant. We attempt to control for both product-specific and cyclical influences on imports. In contrast to some previous results, our findings suggest that denial (restoration) of preferential treatment, i.e. a tariff increase (decrease), has its expected negative (positive) effect.     

Race‐to‐the‐bottom Tariff Cutting

Unilateral tariff liberalization accounts for the lion's share of trade liberalization since the 1980s and has accompanied the most successful trade‐led development model of the past 50 years, “Factory Asia”. Understanding what drove this liberalization is therefore crucial to our grasp of the process of economic development. This paper provides empirical evidence for seven Asian emerging economies from 1988 to 2006 consistent with a tariff race to the bottom driven by a competition for foreign direct investment (FDI). The identification is two‐pronged. First, it is shown that tariffs on parts and components, intermediates and capital goods, crucial locational determinants for assembly firms, are correlated in competitive space, i.e. across countries at a similar level of development, but not across all countries. Second, it is shown that the tariff correlation in competitive space is significantly higher for inputs than consumer goods.     

Tariff Wars and Trade Deals with Costly Government

The authors study a simple model of tariff wars and trade deals in which government revenue collection and disbursement uses resources. The introduction of costly governments leads to lower non‐cooperative tariffs, the possibility that a less costly government may win a tariff war, and fully cooperative trade deals where countries lower tariffs but do not eliminate them, even with lump‐sum taxes and transfers.     

Trade Liberalization and Firm Productivity: Evidence from Chinese Manufacturing Industries

This paper examines the impact of tariff reduction following China's World Trade Organization (WTO) entry on the productivity of Chinese manufacturing firms using a firm‐level panel database that comprises all of China's manufacturing firms with an annual turnover above 5 million yuan and that spans the period of 2000–2006. An instrumental variable estimator is used to account for the endogeneity of the tariff reduction. The results indicate that China's trade liberalization in the five years following its WTO entry has led to a 0.94% annual increase in total factor productivity for Chinese manufacturing firms. However, the overall productivity gain from the tariff reduction is a net result of a productivity depressing effect of output tariff reduction and a productivity enhancing effect of input tariff reduction. Both effects have diminished in magnitude over the years after China joined the WTO. Firm heterogeneity and turnover plays an important role in generating gains from trade liberalization. The surviving firms have managed to cope with and take advantage of lower tariffs. The extent to which the tariff reduction affects Chinese firms' productivity is also dependent on the ownership structure of the firms with foreign‐invested firms being the clear winner.