Trade Liberalization: Winners, Losers and the Collective Action Problem

January 1st, 2003 by MrLuxuryFashionGuru
  

Jason Yeo
Historical Study A-12, Paper 3
Due May 3, 2005 TF: Gregg Peeples  

Question 2.
Classical trade theory tells us that free trade raises aggregate social welfare.  Therefore, a country can raise social welfare by eliminating all barriers to imports.  Yet, few countries reduce such trade barriers unilaterally.  This generates the central puzzle for most of the international political economy: Why do governments adopt policies that render society as a whole worse off?  Focusing on US trade policy in the contemporary era, resolve this puzzle using the Stolper-Samuelson Theorem, and specific factors model, and empirical examples or broader empirical evidence.

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Trade Liberalization: Winners, Losers and the Collective Action Problem  

 

Using the Stolper-Samuelson Theorem and the specific factors model to explain how distributional inequalities of the losses and gains from trade lead to conflicting interests within society, I will argue that the collective action problem means that within representational democracies it is politically difficult to unilaterally reduce trade barriers.  I will support my argument with empirical evidence from contemporary US trade policy to show that in essence, strong domestic political pressures from the workers and business-owners who will be negatively affected by trade liberalization account for the political obstacles to such policies despite their overall positive effect on the national economy.

 

A look at contemporary US trade policy reveals overall progressive moves towards trade liberalization, such as the passage of the North American Free Trade Agreement (NAFTA) in 1993 and the end of quotas on garment imports on Jan 1st, 2005[1].    Yet there have also been the enactment of new protectionist policies such as the imposition of tariffs on imported steel in March 2002[2] and other signs that popular support for free trade is weakening.  For example, President Bush won congressional approval for fast track authority during 2001-2 by just one vote in the House of Representatives[3]; previously, President Clinton had not been able to obtain Congressional fast track approval at all after the implementation of the Uruguay Round in 1994[4].  If economists know that free trade brings net benefits society in the long-run, why has the government adopted policies that make American society as a whole worse off?  While economist Paul Krugman has suggested that ignorance of and disdain for the basic economic truths about international trade might contribute to the enactment of policies unfavorable to trade liberalization[5], political scientists find compelling evidence to assume that legislators are rational actors[6] and that the answers lie in the structural effects of free trade.

Free trade spurs a redistribution of resources within a society according to the market-driven logic of comparative advantage, which leads to greater efficiency and a net gain in aggregate social welfare[7].   However, this redistribution creates both winners and losers in the short- and medium-term as uncompetitive companies go out of business while more competitive firms start up and expand.  Yet because the potential gains from free trade are often indirect, incremental and shared by a large number of consumers and producers over time (e.g. slightly cheaper prices), whereas the losers experience direct, acute effects (e.g. job losses), the potential winners and losers from trade have different incentives to either support or oppose trade liberalization.  The important details here concern who exactly are the losers and winners from free trade, and how strongly they will be motivated to act in their direct immediate interest.  To answer the former question, we will turn to the Stolper-Samuelson Theorem and the specific factors model as complementary approaches to predict the winners and losers from international trade.

The Stolper-Samuelson Theorem describes the phenomenon of factor price equalization under international trade (Oatley, 2004, p.89).  This means that with free trade, the prices of the factors of production (labor and capital) will equalize across all countries.  The Theorem projects that the income of the country’s scarce factor (priced higher than the world price due to local scarcity) will fall with free trade while the income of the country’s abundant factor (priced lower than the world price due to greater supply) will rise as industries relocate to take advantage of these differences and drive up demand within the country.  The factor price equalization model thus posits a clash of interests between Labor interests (workers) and Capital interests (business and property owners), since countries are characterized either by relatively abundant labor and scarce capital (developing countries) or by relatively scarce labor and abundant capital (developed countries like the US).  In the US, we would predict that labor interests would generally oppose trade liberalization while business interests would generally be in support of removing barriers to trade.  Evidence that this hypothesis is correct can be found in the work of Robert Baldwin and Christopher Magee (2000), whose analysis of congressional voting patterns on three key trade votes in the 1990s found, for example, that legislators with a pro-business ideology tended to vote in favor of trade liberalization while those with a pro-labor ideology tended to vote against trade liberalization (Baldwin, 2000, p.41).

While the Stolper-Samuelson Theorem assumes that factors of production are highly mobile across industries, this may not always be valid.  This assumption may be more applicable for less developed economies with a lower-skilled labor force and for low-tech industries (an agricultural worker can just as easily pack boxes of canned food, a sewing machine can be used to make clothes or stuffed toys).  For more developed economies with more sophisticated industries and higher levels of technology and education such as the US, we may assume in many cases that factors of production cannot be easily moved across industries (a mechanical engineer cannot quickly become a computer programmer, a wafer-fabrication plant cannot quickly switch to producing pharmaceuticals).  Additionally, in a large country like the US, the geographic distribution of different industries across different regions adds another barrier to the mobility of labor and capital.  For example, retrenched workers may find it inconvenient or psychologically hard to move across the country to find an equivalently-compensated job in a different sector and heavy machinery may be expensive or dangerous to move.  That is where the specific factors model works as a complementary approach to identifying the winners and losers from trade.  Generally, if labor and capital are relatively industry-specific and cannot be easily shifted to other sectors, then the labor and capital employed in the industrial sectors that rely heavily on society’s abundant factor will both gain from trade.[8]  These industries are referred to as export-oriented industries.  In the US, these would be industries that rely heavily on capital, such as the electronics and telecommunications industries (Oatley, 2004, p.93).  Conversely, sectors of the American economy which rely heavily on labor (collectively referred to as import-competing industries) will lose from international trade.  These industries include the garment and textiles sector and the US steel producers (Oatley, 2004, p.92). 

The specific factors model predicts that the political clash will be among specific industries rather than between labor and capital across different industries.  In particular, export-oriented industries will favor open markets and import-competing industries will favor protectionist economic policies.  In the same 2002 study cited above, Baldwin and Magee also found empirical evidence to support the specific factors approach.  They found that legislators representing districts with high proportions of workers without a high school diploma, with high proportions of unionized workers and with low ratios of export-oriented to import-competing jobs tended to vote against NAFTA in 1993, which was an agreement widely perceived as likely to send low-skilled jobs across the border to Mexico (Baldwin, 2000, p.vi).[9]

It is insufficient to understand how the gains and losses from trade are distributed across industries and factors of production.  We must also explain why it is often easier to enact unilateral protectionist policies than it is to enact unilateral trade liberalization policies.  The answer lies in the concept of the collective action problem.  In each of the two models discussed, economic agents act in their own self-interest, even if they may be aware that these policies will hurt other individuals, companies or industries.  Yet it would not be in an individual’s or company’s best interest to bear the costs of lobbying for some particular trade policy if that actor could simply rely on the efforts of others and enjoy the benefits without cost[10].  This situation describes the classic “free-rider” problem in economics (Mankiw, 2004, p.226).  This also explains why consumers have not played a major role in lobbying for free trade even though they would benefit from such policies in the form of lower prices.  Since the gains to the individual consumer are relatively small, and consumers form a large group where the incentive to free-ride is greater, consumers are much less inclined to lobby for freer trade. 

In contrast, the potential losers from trade liberalization, whether it is only American labor interests or an entire sector, can more easily overcome the collective action problem since they have a more urgent motivation to lobby against free trade (the potential loss of their livelihoods) and together they form a smaller group, where the relative contribution of each labor union or company to the overall lobbying effort is larger, making free-riding less of a problem.  To take this analysis to its logical conclusion, unilateral protectionist policies are politically more feasible because their benefits are concentrated on a small group of producers who can overcome the collective action problem while the costs of protectionism fall upon a larger, heterogeneous group of consumers and producers who find it harder to overcome the collective action problem (Oatley, 2004, p.96).  By similar logic, unilateral trade liberalization measures are politically difficult to enact, and “reciprocal trade agreements transform the large and heterogeneous pro-liberalization interests into smaller groups of export-oriented industries that can overcome the collective action problem.” (Oatley, 2004, p.96)

In closing, it is important to note that I am aware that the Stolper-Samuelson Theorem and the specific factors model are not sufficient to explain all aspects of US trade policy, which may sometimes be better explained by more state-centered explanations that account for national security concerns, foreign policy objectives and “national prestige”, or a more society-centered approach that accounts for societal values such as human rights and environmental issues in developing countries.  However, the empirical evidence available supports the present focus on the winners and losers from trade (which depends on the relative abundance and  mobility of labor and capital) and the incentives to act politically in order to overcome their collective action problem.  As we have seen, together these models offer compelling and powerful explanations of the political difficulties of unilateral trade liberalization policies, and the relative ease of being influenced by better-organized domestic protectionist pressures.

Bibliography

Baldwin, Robert E.
Congressional Trade Votes: from NAFTA to fast track defeat, Institute for International Economics, 2000
Krugman, Paul
Pop Internationalism, MIT Press, 1996
Mankiw, N. Gregory
Principles of Economics, Third Edition, Thomson, 2004
Oatley, Thomas
International Political Economy, Pearson Education, Inc (2004)
Steel Panel Committee on Technology and International Economic Trade Issues
The Competitive Status of the U.S. Steel Industry, National Academy Press, 1985
United States. Congress. House. Committee on Small Business. 
The unintended consequences of increased steel tariffs on American manufacturers : hearing before the Committee on Small Business, House of Representatives, One Hundred Seventh Congress, second session, Washington, DC, July 23, 2002, U.S. G.P.O., 2002.
Warren, Kenneth
Big Steel: The First Century of the United States Steel Corporation 1901-2001, University of Pittsburg Press, 2001
Journal/Newspaper articles
South China Morning Post, “Ruling on quotas a victory for free trade,” Jan 4, 2005, Editorial p.14
The Economist, “Time to Deliver the Goods; World Trade,” Jan 8, 2005
Web resources
Statement of Roberta Baskin, Executive Director
The Center for Public Integrity, Washington D.C., April 7, 2005
http://www.public-i.org/lobby/printer-friendly.aspx?aid=680
Last accessed May 2, 2005
 


   
[1] South China Morning Post, Jan 4, 2005, Editorial p.14 “Ruling on quotas a victory for free trade”   

[2] United States. Congress. House. Committee on Small Business.  “The unintended consequences of increased steel tariffs on American manufacturers : hearing before the Committee on Small Business, House of Representatives, One Hundred Seventh Congress, second session, Washington, DC, July 23, 2002.

[3] The Economist, Jan 8, 2005, “Time to Deliver the Goods; World Trade”
[4] Baldwin, Congressional trade votes: from NAFTA approval to fast track defeat, 2000, p.2
[5] See Krugman (1996), Pop Internationalism, Chapter 5, “The Illusion of Conflict in International Trade”
[6] In this paper, I assume that Congressional legislators are interested in representing the interests of their direct constituents (to gain public support for reelection etc.) and are influenced by industry and labor lobby groups who petition and lobby representatives and senators to act in their economic interests.
[7] See any introductory economics textbook such as Mankiw, Principles of Economics 3rd Ed. (2004)
[8] Oatley, 2004, International Political Economy, p92
[9] Similar evidence on the united lobbying efforts of labor and business representatives from American garment industries and steel producers is cited in Oatley, 2004, p.92
[10] These costs can be very high.  According to the Center for Public Integrity, in 2003 lobbyists reported spending about $2.4 billion.  (http://www.public-i.org/lobby/printer-friendly.aspx?aid=680,)

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