Endogenous Protection: Lobbyingfaculty.arts.ubc.ca/ftrebbi/590_lectures/LobbyProtection.pdf · and...

Endogenous Protection: Lobbying

Matilde Bombardini

UBC

January 20, 2011

Bombardini (UBC) Endogenous Protection January 20, 2011 1 / 24

Protection for sale

Grossman and Helpman (1994) �Protection for Sale�American EconomicReviewTwo approaches to endogenize protection as outcome of political process:explicitly model political competition: elections and trade policy (e.g.Hillman and Ursprung (AER 1988))incumbent politicians maximize �political support� (elections are notexplicitly modeled) (e.g. Hillman (1989))This paper follows second strand of literatureThis model provide a micro-foundation of political support function


Main ingredients

Small open economySpeci�c factors model of tradeInterest group = speci�c factorPolitical organization is exogenous (some interest groups do not lobbygovernment)No electoral competition, interest groups lobby incumbent government


Interest groups o¤er monetary contributions to the government as afunction of tari¤sGovernment may value monetary contributions for electoral reasonsGovernment also cares about general welfare (again, potentially related tore-election concerns)Tari¤s result from trading o¤ monetary contributions and welfare lossderiving from protection


The economy and preferences

Small economy, population size NPreferences are quasi-linear:

u = x0 +n

∑i=1ui (xi )

ui (�) increasing, concave and di¤erentiablex0 is numeraire, freely tradedother goods potentially bear a tari¤:p�i international pricepi domestic price


Preferences

Quasi-linear utility kills income e¤ectsConsumption of good i depends only on piconsumption of xi is di (pi )rest of expenditure E spent on x0 : E �∑n

i=1 pidi (pi )Indirect utility function:

V (p,E ) = E + s (p)

This is convenient because it reduces the degree of interaction amongsectors


Production

x0 is produced using only labor (one to one)assume the production of x0 is positive =) w = 1xi is produced under CRS with:laborsector i speci�c input (capital, human capital, etc.)Return to speci�c factor πi (pi )Using Hotelling�s lemma output is given by:

yi (pi ) =dπidpi


Trade Policy

Restrict policy space to tari¤sSubsidies are more e¢ cient, not allowed hereNet tari¤ revenues are redistributed back to consumersper capita:

r (p) =n

∑i=1(pi � p�i )

�di (pi )�

yi (pi )N

�total imports mi (pi ) = Ndi (pi )� yi (pi )


Political organization

Owners of speci�c factor i have stake in price of good iMay or may not organize politicallySet L of sectors organize:within each sector owners of speci�c factor form a cohesive interest groupno modelling of incentives to organizeno free-riding within sector


Lobbying the government

Technical innovation of paper is employing menu auction (Bernheim andWhinston, QJE 1986)Set of L interest groups try to induce government to choose costly action:common agency problemEach lobby i submits a contribution schedule Ci (p)�menu� in the sense that it associates a monetary amount to each possibleprice vectorThe government chooses an equilibrium price vector p0 (which translatesinto tari¤s) and collects contributions


Joint welfare of members of the lobby:

Wi (p) = `i + πi (pi ) + αiN [r (p) + s (p)]

where `i is labor income of members of lobby i and αi is share ofpopulation represented by owners of sector i speci�c factor


Government

Unitary government (no congress/parliament)No explicit electoral competitionGovernment payo¤:

G = ∑i2LCi (p) + aW (p)

Aggregate welfare:

W (p) = `+∑i

πi (pi ) +N [r (p) + s (p)]

where ` is total labor income in the country


Solution

Bernheim and Whinston (1986) emphasize, among possible equilibria,those sustained by Truthful Contribution schedulesTruthful contribution schedule:

CTi (p,Bi ) = max [0,Wi (p)� Bi ]

Truthful in the sense of re�ecting everywhere the willingness to pay for p(no asymmetric information here)Truthful Nash Equilibria have the important property of beingcoalition-proof and truthful contributions are always in the best-responsecorrespondence


Under these contribution schedules, the maximization problem for thegovernment is:

p0 = argmaxp2P

"∑i2LWi (p) + aW (p)

#

FOC:

∑i2LrWi

�p0�+ arW

�p0�= 0

Impact of change in pi on lobby i welfare:

∂Wi

∂pi= yi + αi

�mi + (pi � p�i )m0i � di (pi )

�Similarly impact of change in pj on lobby i welfare:

∂Wi

∂pj= αi

��pj � p�j

�m0j � yj (pj )

�Bombardini (UBC) Endogenous Protection January 20, 2011 14 / 24

Impact of change in pj on aggregate welfare:

∂W∂pj

=�pj � p�j

�m0j +mj| {z }

∂r (p)/∂p

�dj (pj )| {z }∂s(p)/∂p

+ yj (pj )| {z }∂π(p)/∂p

∂W∂pj

=�pj � p�j

�m0j

Verify that optimal tari¤ is zero in the absence of lobbying =) seeGrossman and Helpman (JPE 1995) for large country model with interestgroups (optimal tari¤ considerations)Substitute in the �rst order condition and rearrange to �nd the equilibriumlevel of protection


Equilibrium level of protection

Unique equilibrium in the tari¤ level (multiple equilibria in level ofcontributions sustaining it):

t0it0i + 1

=Ii � αLa+ αL

�z0ie0i

�where z0i is the inverse import penetration yi

�p0i�

/m�p0i�and e0i is the

elasticity of import demandIi is an indicator function that is 1 if lobby i is politically organized and 0if lobby i is not organized�Ramsey rule� for protectionFor politically organized sectors protection:is decreasing in elasticity of imports (more distortionary if e is high)decreasing in import penetration (more distortionary if imports are a largefraction of consumption)lower if αL higher (more lobbying to lower tari¤)higher if a is lower (lower weight on welfare)


For politically unorganized sectors: import subsidy (αL share of populationlobbying to reduce price of imports)decreasing in import penetration and import elasticity for same reasonslarger subsidy if αL is large (more lobbying)


Political contributions

Multiple equilibria in the level of contributions supporting tari¤s t0iGiven truthful contribution schedule, each interest group i will try to lowercontributions as much as possible (increase Bi ) without forcing thegovernment to ignore them when setting tari¤sImagine without interest group i the government would choose pricevector p�i

The interest group i will lower its contributions to keep governmentindi¤erent between p�i and p0

∑j 6=iCj�p�i ,Bj

�+ aW

�p�i�= ∑

jCj�p0,Bj

�+ aW

�p0�

There might be multiple levels of contributions that satisfy this condition


The amount of contributions and therefore the way the surplus is splitbetween lobbies and government depends crucially on competition amonginterest groupsIf αL = 0 there is NO competition among lobbies (no one is lobbying toreduce the price on other products);=) if government ignored sector i it would set tari¤ to zero (free trade)=) sector i has to pay ε contribution to keep gov�t indi¤erentIf αL = 1 maximum competition, entire population is lobbyingno protection (tari¤s are zero)but government is appropriating all rentsinterest groups are paying just to prevent government to place importsubsidies on their product


Evidence on the Protection for Sale model

Two papers: Gawande and Bandyopadhyay (Restat 2000) and Goldbergand Maggi (AER 1999)Follow GBData for 1983 on:tari¤s and non-tari¤ barriers (coverage ratios)import penetration ratiosimport elasticityPAC monetary contributions


Use political contributions to classify sectors into politically organized ornot: GB try to identify the part of campaign contributions related to tradeEmpirical speci�cation:

ti1+ ti

= γ0 + γ1Iiziei+ γ2

ziei+ Z1i + εi

Taking into account that import penetration depends on protection(Tre�er 1993):

1zi= δ0 + δ1

ti1+ ti

+ Z2i + ηi


Endogenizing political organizationMitra (1999)

D. Mitra (1999) �Endogenous Lobby Formation and EndogenousProtection: A Long Run Model of Trade Policy Determination�AmericanEconomic ReviewIntroduces a �xed cost of organization at the level of the interest groupPosits that lobby will organize if total surplus created by lobbying is largerthan �xed cost


Endogenizing political organizationBombardini (JIE 2008)

� Firm heterogeneity and lobby participation�Shift perspective to individual �rmsEmpirically, in GB-type regression average �rm size and dispersion (s.d.)of �rm size a¤ect positively protectionModel individual �rms decision to participate in the sector lobby and pay�xed cost of lobbyingObtain a �modi�ed�GH prediction:

t0it0i + 1

=θi � αLa+ αL

�z0ie0i

�Measured θi for each sector and tested against GH


Endogenous Protection: Lobbyingfaculty.arts.ubc.ca/ftrebbi/590_lectures/LobbyProtection.pdf · and...

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