Endogenous Protection, Trade Negotiations, and the GATT · Endogenous Protection, Trade...
Transcript of Endogenous Protection, Trade Negotiations, and the GATT · Endogenous Protection, Trade...
Endogenous Protection, Trade Negotiations, and the GATT
Richard Sherman
Department of Political ScienceMaxwell School of Citizenship and Public Affairs
Syracuse UniversitySyracuse, NY 13244-1090
tel. 315-443-9119fax 315-443-9082
e-mail [email protected]
For helpful discussions and comments on an earlier draft I thank James Caporaso, SteveChan, Thomas A. Dunn, John Odell, Michael Taylor, and three anonymous reviewers.
Abstract
The best existing models of trade policy derive from endogenous protection theory,which explains the tariff as a function of domestic-level demands for protection and ofthe willingness of governments to supply it. Absent from the theory are the international-level processes and institutions that govern trade policy, particularly the GeneralAgreement on Tariffs and Trade. I argue that the GATT, by institutionalizing tradenegotiations, has transformed trade politics from a political market for protection into apolitical contest between exporters and import-competitors. This has severed the tarifffrom macroeconomic fluctuations and weakened the effects of partisanship on tradepolicy. Tariffs in the major trading states respond instead to the tariffs of their mainnegotiating partners. I test this hypothesis in an econometric analysis of tariffs in theUnited States, Japan, and the European Community in the period 1953-1994, findingstrong evidence of tariff interaction and virtually no evidence to support standardendogenous-protection hypotheses.
1
Trade policy in democracies is the result of a competitive political process involving
voters, parties, and organized interest groups. This simple proposition motivates some of
the most successful explanatory models of trade policy to have emerged over the past two
decades, known collectively as endogenous protection theory. Standard models in this
tradition hold that the level of protection is a function of macroeconomic and political
variables, which are construed respectively as indicators of the demand for protection and
of the propensity of governments to supply it.1 Equipped with well-articulated theoretical
foundations and with the support of repeated empirical tests, endogenous protection
theory has emerged as a standard for research on the political economy of trade policy.
Absent from endogenous protection theory's research program, though, is an
examination of the political processes and institutions that govern contemporary trade
policy at the international level––specifically, the institutional system embodied in the
General Agreement on Tariffs and Trade (GATT) and its inheritor, the World Trade
Organization (WTO). This absence is noteworthy in that the GATT was designed to
thwart some of the connections between trade policy and the demand for protection that
are central to endogenous protection theory. The GATT has sought to link together the
tariffs of the major trading states, to bind negotiated tariffs against increase, and to
intervene in domestic political competition by engaging the interests of exporters in an
ongoing process of negotiated liberalization. The GATT/WTO is, at its core, an
1 See, e.g., Baldwin 1985; Bohara and Kaempfer 1991a, 1991b, 1992; Das and Das 1994; Henriques andSadorsky 1994; Krol 1996; Lohmann and O'Halloran 1994; Magee, Brock and Young 1989; Mansfield andBusch 1995; O'Halloran 1994; Salvatore 1987; Takacs 1981.
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institutional effort to sever the connection between protectionist demands and trade
policy.
In this light, endogenous protection theory's success can be seen as a measure of the
GATT system's failure. Anecdotal evidence amply supports the hypothesis that the
GATT has facilitated trade liberalization, but systematic evidence on the determinants of
trade policy points in the other direction: the institution appears to be epiphenomal to the
domestic-level political process that causes variation in the tariff. Since endogenous
protection models have not been tested against an alternative theory that incorporates the
effects of the GATT/WTO on trade policy, it remains an open question whether the
institution has had a significant effect on commercial openness in the major trading
states.
This article examines the effects of international institutionalization on domestic-level
political competition over trade policy. The central argument is that the GATT has
transformed domestic-level trade politics from a simple political market for protection––
one in which protection is available to any group that expends sufficient resources on
lobbying––into a political contest in which exporters and protectionists compete for
influence, pursuing policies that are generally at odds with each other. As the
institutional background against which trade policy is contested, the GATT system has
had three principal effects. First, by linking home and foreign tariffs together through an
ongoing negotiation process, it has motivated organized interest groups in exporting
sectors to lobby for negotiated trade liberalization. Second, it has severed the connection
3
between trade policy and fluctuations in the business cycle, since both exporters and
import competitors respond to macroeconomic conditions by lobbying for favorable (but
opposite) policy changes. Third, due to institutionalized negotiation under GATT rules,
the contest between exporters and import competitors has become biased in favor of
exporters. This has weakened the effect of partisan control of government on trade
policy: regardless of party, the political benefits of protection are increasingly
outweighed by the political benefits available from catering to exporting interests.
The central empirical implication is that the average tariffs of the major trading states
respond to the tariffs of their main negotiating partners in the GATT/WTO, but not to
domestic-level political and economic variables commonly employed in endogenous
protection theory: inflation, unemployment, economic output, and partisan control of
government. I test this hypothesis in an econometric analysis of tariffs in the US, Japan,
and Germany in the period 1953-1994. The results support the hypothesis that the
multilateral system has transformed trade politics: each country's tariff responds
significantly to foreign tariffs, while virtually no connection is found between the tariff
and domestic political and economic conditions.
These results challenge both conventional wisdom and a considerable body of
empirical research on the political economy of trade policy. At the same time, they
address a central controversy in international relations research: the effect of
international institutions on state behavior. The core of the liberal/realist divide in
international relations theory, the controversy concerns the ability of institutions to
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enhance prospects for international cooperation. Despite the effort that has gone into
making the case for international institutions, the systematic evidence supporting claims
of institutional effectiveness is not compelling.2 Endogenous protection theory's
contribution to this controversy comes in the form of empirical results consistent with the
hypothesis that international institutions have no effect on state behavior.
The results reported here strengthen the case for international institutions, at least in
the area of trade policy. I find that the GATT/WTO has succeeded in linking the tariffs
of the major trading states through an ongoing negotiation process and in establishing a
domestic-level political contest that is biased in favor of the proponents of negotiated
liberalization. These effects have been achieved without appreciable surrender of
sovereignty to supranational institutions and without central or hegemonic enforcement
of the institution's rules.3 The global trade institution has not only influenced trade
policy; it has severed the connection between the tariff and the demand for protection.
In the next section, I develop the central argument of the article: that tariff levels in
the major trading states during the GATT/WTO era respond to each other, but not to
domestic-level political and macroeconomic conditions. In the third section, I report the
results of an econometric test of the argument using data on US, Japanese, and German
2 See Keohane and Martin 1995; Kupchan and Kupchan 1995; Mearsheimer 1994, 1995; Ruggie 1995.3 Yarbrough and Yarbrough (1992) offer the view that free trade under the GATT is enforced by ahegemonic state (the US), but their argument is mistaken. GATT agreements are enforced principallythrough self-help measures and multilateral dispute settlement procedures.
5
tariffs from 1953-1994.4 The fourth section discusses issues not taken up in the empirical
analysis (including non-tariff barriers), and it concludes. The appendix provides data
sources and additional details of the econometric analysis.
Political markets, political contests, and negotiated trade policy
The best economic argument against trade protection is that it benefits special
interests at the expense of the economy at large. Alas for the economy, this is also the
best political explanation for why protection exists. The costs of protection are
distributed widely (among consumers and owners of the abundant factor of production),
while its benefits accrue to smaller groups that are more readily organized (firms,
industries, and owners of the scarce factor of production). The collective action problem
facing advocates of trade liberalization is therefore greater than the problem facing
protectionists. Due to the bias in political representation favoring organized groups over
unorganized ones, trade policy––when determined entirely as a domestic matter––tends
to favor protectionists over free traders.
Trade policy in the purely domestic setting resembles a political market: protection is
available at a price (measured in lobbying expenses, campaign contributions, or bribes),
and groups willing to pay the price can expect to receive it. The price of protection and
4The German tariff is used here as a proxy for the European Community's external tariff. See the appendixfor details on data sources.
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the value of pursuing it are related to political and economic conditions that may be taken
as exogenous: partisan control of government, unemployment, inflation, economic
growth, and other economic indicators. Variation in these exogenous conditions in the
political economy is therefore taken as a likely predictor of the aggregate level of
protection.
While the concept of a political market is intriguing, it is misleading as a metaphor
for contemporary trade politics in the major trading states. On offer on the political
market is not only domestic protection but also its opposite, foreign trade liberalization.
The two are "opposite" in that each comes at the cost of the other: substantial gains in
access to foreign markets require corresponding reductions in domestic trade barriers, and
a rise in domestic protection is likely to be met with a retaliatory response abroad. The
political market for trade policy is thus not a market but a contest, with spoils transferred
from losers to winners.
The market metaphor worked well for trade politics before the GATT because the
losers, being principally unorganized, did not take part in the contest. In his analysis of
the politics of the Smoot-Hawley Tariff Act of 1930, Schattschneider wrote that "the
pressures supporting the tariff [were] made overwhelming by the fact that the opposition
[was] negligible."5 Such was the scale of the protectionist bias in interest-group activity
and influence, argued Schattschneider, that the legislation would have been little different
5 Schattschneider 1935: 285.
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had there been no opposition to it at all.6 The Smoot-Hawley tariff was the result of a
formally democratic process to which only protectionists had effective access.
Some sixty years after Schattschneider's analysis, Congress's actions on the Uruguay
Round agreement indicate that a substantial shift in US trade politics had taken place. In
hearings before the Senate Finance Committee, public witnesses favoring the new GATT
agreement outnumbered the agreement's opponents by more than two to one. Of the
written communications received by the committee, eleven were in favor of the
agreement and only three opposed.7 Not only the traditional beneficiaries of trade
liberalization (importers and import-dependent industries) lined up on the side of the
Uruguay Round agreement. Along with them were industry coalitions such as the US
Chamber of Commerce, the Intellectual Property Committee, and the Alliance for GATT
Now. Eight months after the hearings, substantial majorities of both parties in both
houses of Congress voted to implement the agreement.8
The transformation of the trade policy landscape can be attributed to two institutional
changes. First, the Reciprocal Trade Agreements Act (RTAA) of 1934 delegated
considerable tariff authority from Congress to the President,9 allowing the President to
proclaim negotiated tariff reductions into law without Congressional action (or later,
under fast-track authority, requiring a yes-or-no vote by Congress with no amendments).
Second, the 1947 General Agreement on Tariffs and Trade established an institutional
6 Schattschneider 1935: 109.7 Committee on Finance, US Senate 1994: 66-78, 82-105, 108-30.8 Preeg 1995: 181-183.
8
framework for international negotiations on trade policy. As a result, the tariffs of the
major trading states were linked together: they would rise together as a result of
retaliatory withdrawals of concessions or fall together in consequence of negotiated
reductions. The GATT, including among its members most of the world's industrial
democracies, provided an institutional context in which multilateral negotiations became
routine.
Since domestic protection could be traded away for access to foreign markets, the
benefits of lobbying against protection were no longer spread as thinly as in earlier eras.
Organized interest groups in export sectors could reap concentrated benefits by
advocating negotiated liberalization, and protectionists would have not only to gain
political access but to defeat exporters in a political contest in order to succeed. The
GATT did not extinguish pressure for protection, nor did it abolish the special-interest
politics of trade in favor of a political calculus based on general interests. Instead, it
motivated special interests in exporting sectors to organize and lobby for trade
liberalization.
Gilligan emphasizes the role played by the RTAA in the transformation of US trade
politics.10 While this Depression-era legislation was crucial for American trade policy, it
had no direct effect on other countries' trade laws, nor did it establish an institutional
forum for multilateral negotiations. The RTAA's effects on policy are simple enough to
establish––the average US tariff fell by almost 50% in the decade following the act's
9 See Destler 1995; Gilligan 1997
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passage––but it is less straightforward to identify independent effects of the RTAA on
interest-group competition. Depression and then war meant that the years between the
RTAA's passage and the origin of the GATT were extraordinary, combining an urgent
Keynesianism with a militarized foreign policy. Viewed through an American lens, the
RTAA marks the transformation of trade politics. From a cross-national perspective, the
creation of the GATT is the decisive moment.
Negotiated trade policy and macroeconomic conditions
The central insight of endogenous protection theory is that the pursuit of protection
by firms, industries, labor unions, and other lobbying groups may be systematically
related to economic and political variables. At the aggregate level, this implies that
macroeconomic conditions have predictable effects on the level of protection.11 Crucial
to these effects is that each independent variable influences the tariff in a single direction
on average. For example, inflation is said to give rise to demands for reductions in tariffs
as a means of taking pressure off prices.12 For the inflation-protection link to survive,
10 Gilligan 1997.11 A variety of endogenous protection theory not considered here deals with the structure of protection.Models of the structure of protection explore the relationship between industry characteristics and industry-level trade barriers in order to assess the relative political influence of sectoral interest groups. See, e.g.,Hansen 1990; Lavergne 1983; Trefler 1993.12 Bohara and Kaempfer 1991a; Lohmann and O'Halloran 1994: 621; Magee, Brock and Young 1989: 188.This argument is problematic, as it requires voters to subscribe to a perverse macroeconomic theory inwhich tax cuts lead to reductions in inflation.
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inflation must influence trade policy in a single direction––in the standard treatment, the
effect must be to reduce protection on average.
The effect of economic aggregates on the demand for protection derives from
variation in the value of lobbying relative to directly productive economic activity. As
the economic return to the directly productive activity of an industry or labor union falls,
the relative value of lobbying for policy rises.13 Since some of this political activity may
be directed toward trade policy, adverse economic conditions can be expected to lead to
demands for changes in the level of protection.
Under negotiated trade policy, though, this logic cuts both ways: just as import
competitors respond to adverse economic conditions by demanding protection, so do
exporters respond by demanding negotiated liberalization in order to gain expanded
access to foreign markets. While the two groups lobby for opposite changes in policy,
aggregate economic conditions have identical effects on their incentives to lobby. To
clarify this point, I briefly consider five variables often employed in endogenous
protection models: the trade balance, inflation, unemployment, exchange rates, and GDP
growth.
The trade balance nicely illustrates the problematic link between macroeconomic
variables and negotiated trade policy. The trade balance simply subtracts imports from
exports, thus indicating in one figure the performance of export industries and of import-
competing industries. In endogenous protection models, a decline in the trade balance is
13 Magee, Brock and Young 1989: 185-186.
11
generally expected to result in a rise in protectionist pressure;14 this follows from the
premise that the trade balance measures the economic fortunes of import competitors.
What it misses is that the trade balance also measures the fortunes of export industries,
which are expected to respond to a declining trade balance by pressing for negotiated
liberalization. By combining exports and imports in one figure, the trade balance also
combines the expected effects on lobbying by protectionist and antiprotectionist groups.
Since the groups lobby for opposite policy changes, the combined effect does not
theoretically influence the tariff in a single direction.
Inflation, unless it is exactly compensated by changes in the exchange rate, harms
producers in both export and import-competing industries. Inflation raises the price of
domestically produced goods––both those produced for export and those produced for the
domestic market––relative to the world price of competing goods. If inflation gives
either group an incentive to lobby for changes in trade policy, then it gives the same
incentive to both groups: import competitors are expected to seek higher tariffs, while
exporters are expected to pursue lower foreign tariffs (and thus, through negotiation,
lower domestic tariffs).
Unemployment, a symptom rather than a cause of industry-level economic woes, has
similar cross-cutting political effects. Either due to its direct effects on workers or as an
indicator of surplus capacity, unemployment reflects poor performance in the economy as
14 Bohara and Kaempfer 1991a; Coughlin, Teerza and Khalifah 1989; Das and Das 1994; Feigenbaum,Ortiz, and Willett 1985; Henriques and Sadorsky 1994; Krol 1996; Magee, Brock and Young 1989: 189-194; Salvatore 1987; Takacs 1981.
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a whole. If this aggregate economic condition were specific to one group (import
competitors or exporters), it could be expected to exert a unidirectional effect on trade-
policy lobbying. Since this is not generally true, unemployment resembles inflation in its
effects on trade lobbying: if unemployment gives one group an incentive to lobby for
changes in trade policy, then it gives the same incentive to the opposing group.
Exchange rates have been singled out in some recent research as prime motivators of
protectionist political activity.15 This may be true, since an increase in the value of the
home currency causes imports to fall in price relative to domestic substitutes. A highly
valued currency, though, is as harmful to exporters as to import competitors, since it
raises the price of exportable goods relative to the world price of competing products.
Both groups benefit from a cheap currency and are harmed by an expensive one; the
lobbying incentives given to each group by exchange-rate changes are therefore identical.
Endogenous protection models commonly assert that GDP growth exerts a negative
effect on protection.16 This hypothesis suffers from the same defect as the hypothesis
linking protection to the trade balance: slow economic growth harms both import
competitors and exporters, who are expected to lobby for opposite policy changes. By
claiming that governments respond to slow economic growth with tax increases, it also
implies that governments subscribe systematically to a perverse macroeconomic policy.
Still, a psychological model of behavior by voters and politicians may be at work in the
15 Mansfield and Busch 1995; Dornbusch and Frankel 1987.16 Bohara and Kaempfer 1991a, 1991b; Henriques and Sadorsky 1994; Salvatore 1987; Takacs 1981.
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hypothesis linking GDP growth to the trade balance, and historically it is hardly unheard
of for governments to raise tariffs in response to economic downturns. A simple
bivariate regression of the differenced tariff on the current differenced GDP growth rate
in the United States, Japan, and Germany over the period 1953-1994 yields mixed results.
In the United States, GDP growth exerts a significant positive effect on the tariff; in
Germany, it exerts a significant negative effect; and in Japan, there is no significant
relationship between the two variables.17 Similar regressions using lagged differenced
GDP growth indicate no significant effect on the tariff in any of the three countries.
From a cross-national perspective, GDP growth does not appear to have a systematic,
unidirectional effect on the tariff.
Partisan control of government and the GATT/WTO system
It is sensible to expect that partisan control of government influences trade policy,
since political parties frequently (if decreasingly) take different rhetorical positions on
trade. Unlike macroeconomic effects, partisan effects on the tariff are still theoretically
present under negotiated trade policy; however, they are expected to be weaker than in a
strictly domestic-level trade policy regime. The simplest reason for this is that the
17 In the United States, the coefficient on GDP growth is 0.04 with a White standard error of 0.02,significant at the 0.05 level. In Japan, the coefficient is 0.003 with a standard error of 0.07, (in)significantat the 0.94 level. In Germany, the coefficient is -0.06 with a standard error of 0.02, significant at the 0.05level. The equations for the US and Japan are estimated as AR(1) processes in order to compensate forserial correlation.
14
GATT/WTO represents a deliberate effort to bring about negotiated reductions in trade
barriers. Parties in power thus find themselves in an institutional context of trade
diplomacy predisposed toward liberalization. Protectionist and free-trading governments
alike inherit negotiations begun by their predecessors in office, tariffs bound by previous
negotiations, and international rules limiting the protectionist impulse.
Stripped to its essentials, the GATT is a prohibition on three things: the
discriminatory application of trade barriers, the use of most quantitative restrictions, and
the raising of tariffs bound by previous negotiations. Like all systems of international
law, the GATT is imperfect, and its rules are occasionally violated; still, adherence is the
norm rather than the exception for trade in most nonagricultural goods. For an analysis
of partisan effects on the tariff, the binding of tariffs is of central importance: a state can
raise bound tariffs only at the expense of withdrawals of concessions by foreign states.
The cost of such a protectionist move is thus borne directly by the country's export
industries. By the conclusion of the Tokyo Round, industrialized countries had bound
94% of their nonagricultural tariff classifications on average.18 The practical
consequence is a rather extreme restriction on the ability of protectionist parties to raise
tariffs.
Along with tariffs used in administered protection (such as countervailing duties),
unbound tariffs remain available for governments intent on restricting imports. These
instruments, though, contribute only marginally to a country's average tariff, the
18 Preeg 1995: 191
15
dependent variable in most empirical studies of endogenous protection. The strongest
effect that protectionist parties are likely to have on the average tariff comes simply from
doing nothing; that is, stalling in negotiations, withholding concessions, or refusing to
negotiate at all.
This they do. Yet, in a context of negotiated trade policy, these behaviors are not
distinct from what would be expected of a government inclined toward free trade. As
long as there is a political payoff to protection, governments of either free-trading or
protectionist persuasions stand to gain by extracting maximally valuable concessions
from foreign states in exchange for minimally painful domestic concessions. No
negotiator could expect to achieve this objective without playing the role of a hard
bargainer; i.e., without signaling, falsely or otherwise, that her government has
protectionist preferences. For free-trading and protectionist governments alike, giving
the impression of reluctance is part of the process of negotiation. Indeed, analytical
narratives of GATT negotiations give evidence of far less enthusiasm for trade
liberalization than might naively be expected among states convened for exactly that
purpose.19
This does not imply that the negotiating strategies of protectionist and free-trading
governments will exactly converge. It does imply that negotiated outcomes are dyadic
rather than monadic in nature, reflecting the interaction of several states' preferences
rather than the preferences of a single state. A free-trading government may well fail to
19 Dam 1970: 56-78; Grieco 1990; Jackson 1989; Preeg 1970, 1995.
16
negotiate large tariff cuts if its negotiating partners are protectionists; similarly, a
protectionist government may negotiate larger-than-expected tariff cuts if it faces free-
trading states across the negotiating table. Due to the dyadic nature of bargaining
outcomes, negotiated trade policy tends to weaken the relationship between partisan
control of government and the tariff.
Institutionalized negotiations under the GATT have also made trade liberalization less
politically costly (and protection more so) than in the institution's absence. A norm of
reciprocity, in which the major trading states make roughly equivalent cuts in trade
barriers, has governed GATT negotiations since the early 1960s at latest.20 The effect of
reciprocity is to minimize the severity of distributive conflict in trade negotiations, so that
states can expect not to cede more market access than they gain. Table 1 provides
evidence that reciprocity has been at work in trade policy interactions among the United
States, Japan, and Germany during the period 1953-1994. The table gives summary
statistics of the annual difference between the states' differenced tariffs across all three
pairs (US-Japan, US-Germany, and Japan-Germany), along with one-sample t-tests of the
hypothesis that the mean difference in each pair is not equal to zero. In all cases, the null
hypothesis of equal mean tariff changes is clearly accepted.21
20 Dam 1970: 58-78.21 The null hypothesis of equal means is accepted under both directional and directionless forms of the ttests.
17
Table 1. Tests of equality of differenced tariffs across pairs of states, 1953-1994
Variable Mean 95% conf. interval t (H0:mean=0) prob > |t|
∆US tarifft – ∆Japanese tarifft -.072 -.230 .087 -.91 .37
∆US tarifft – ∆German tarifft .043 -.128 .213 .51 .62
∆Japanese tarifft – ∆German tarifft .114 -.108 .336 1.04 .30
18
In the absence of the reciprocity restriction, governments in less powerful states
might expect to lose political support through negotiations, having to open their markets
more widely than their stronger negotiating partners. Reciprocity allows weaker states to
gain from negotiations despite their unpromising bargaining positions. For both weak and
strong states, the norm of reciprocity tips the scales of domestic political competition
moderately in favor of exporters: even if reciprocity means that exporters' gains are
exactly offset by import competitors' losses, consumers still gain from tariff reductions.
These arguments suggest that partisan effects on the tariff are weakened, and
macroeconomic effects possibly eliminated, by the GATT/WTO's system of negotiated
trade policy. Each country's tariff responds instead to the tariffs of its main negotiating
partners. Empirically, it is of course possible that macroeconomic conditions, while
stimulating both protectionist and antiprotectionist lobbying, work more strongly in one
direction than the other on average. It is also possible that the GATT/WTO, while
seeking to bias trade policy in a liberalizing direction, has failed to weaken the
connection between partisan preferences and trade policy. These questions can be
resolved only through empirical analysis, the subject of the next section.
An empirical analysis of international and domestic effects on the tariff
An empirical assessment of the hypothesis that a country's tariff responds to the
tariffs of its negotiating partners must confront two related issues. First, the causal
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relationship between the tariffs of, say, Japan and the United States operates in both
directions: the Japanese tariff influences the US tariff because the US tariff influences
the Japanese tariff. Estimating the US tariff as a function of the Japanese tariff thus
raises the econometric problem of endogeneity in the explanatory variables, which is
typically handled by means of instrumental-variables techniques such as two-stage least-
squares (2SLS). The technique requires selection of a set of instrumental variables to
predict the endogenous explanatory variable (in this example, the Japanese tariff) in a
first-stage regression; the predicted values from the first-stage regression are then used as
proxies for the observed values of the endogenous explanatory variable in a second-stage
regression.
The second problem is related to the first and to the theoretical argument presented
above. To generate an appropriate set of instrumental variables for, say, the Japanese
tariff, one must construct a model of the Japanese tariff that fits the data reasonably well.
The difficulty raised by this procedure is that the best existing models of variation in the
tariff are those based on endogenous protection theory, and even those models often fail
to provide a good fit to the data. One of the variables commonly included in
endogenous-protection models––the inflation rate––is included among the instrumental
variables used in the 2SLS estimations I report here, along with other variables that
improve the fit of the first-stage regressions. What makes this procedure reasonable is
that the first-stage regressions in 2SLS estimation are intended only to provide a good fit
20
to the data, not to explore or establish the statistical significance of the covariates used to
predict the endogenous explanatory variables.
The data used for the analysis cover three countries (the United States, Japan, and
Germany) and 42 years (1953-94). The data for the main equations include the tariff rate
(measured as 100 × customs revenues divided by imports), producer-price inflation, the
unemployment rate, the real GDP growth rate, political variables, and foreign tariffs. For
Germany and Japan, the political variables are the seat shares (respectively) of the
Christian Democratic Union/Christian Social Union in the Bundestag and of the Liberal
Democratic Party in the Japanese House of Representatives. For the United States, the
political variables are dummies representing the party of the President (1=Republican,
0=Democrat), the majority party in Congress (1=both houses Republican, 0 otherwise),
and split control of Congress (1 if the majority party in the House is not the same as the
majority party in the Senate, 0 otherwise).
These three countries are chosen due to the predominant role played by the US,
Japan, and the European Community in GATT negotiations. Representing large markets
and large shares of world trade, these three have acted as agenda-setters for GATT
negotiating rounds, and the negotiations themselves have centered mainly on issues of
interest to these three actors. The German tariff is used as a proxy for the EC common
external tariff after 1965––that is, the tariff is calculated as 100 × customs revenues
divided by all German imports before 1965; beginning in 1965, imports only from non-
EC member countries are used in calculating the German tariff. The choice of the year
21
1965 is made mainly on statistical grounds. The EC's common market was phased in
over the decade following the 1957 signing of the Treaty of Rome; selecting any given
year as the initial year of the common market is thus somewhat arbitrary.22 Treating
years other than 1965 as the initial year of the common market results in a large jump in
the series in and immediately after the initial year. The size of the apparent one-year
jump in the tariff is minimized when 1965 is chosen as the initial year of the common
market.
Since all three of the tariff series exhibit unit roots, they are differenced once in order
to induce stationarity. The independent variables are also differenced, with one
exception: the US political dummies are kept level, since in differenced form they
measure not partisan control but merely changes from one party to another. The
macroeconomic and political explanatory variables are lagged one period in order to take
account of the delay between demands for policy changes and policy changes themselves.
In the generic equation to be estimated for the three countries, the differenced
domestic tariff is the dependent variable; explanatory variables include the
macroeconomic and political variables discussed above and, in separate equations, each
of the other two countries' current differenced tariffs. The foreign tariffs are not lagged
since the hypothesis linking them to domestic tariffs through GATT negotiations suggests
that they influence each other simultaneously: rather than being determined through
22 Hayes 1993.
22
tacit, tit-for-tat style cooperation, the tariffs are explicitly linked via timetables for
implementation of negotiated reductions.
The first step in the analysis is to generate a set of instrumental variables to estimate
the foreign tariffs in each equation. The instrumental variables are the lagged tariff,
producer-price inflation, and imports in local currency at current prices, all in first
differences. To clarify this with an example: in equations in which the differenced
Japanese tariff appears as an explanatory variable, the instrumental variables include
differenced Japanese inflation, differenced Japanese imports, and the previous year's
differenced Japanese tariff. These instrumental variables were selected through a process
that began with a complete list of standard endogenous-protection variables (inflation,
unemployment, GDP growth, lagged tariffs, and partisan control of government) and then
eliminated variables that failed to contribute substantially to the fit of the first-stage
regressions. Imports were added to the instrument list in order to improve the fit of these
first-stage estimates.
The second step in the analysis is to insure that the domestic tariff is exogenous to the
instrumental variables. To accomplish this, I estimate models in which the domestic
tariff is predicted as a function of domestic political and economic variables, foreign
tariffs, and the instrumental variables. Wald tests are conducted against the null
hypothesis that the coefficients on the instrumental variables are all equal to zero.
Rejection of the null is evidence of failure of exogeneity of the instrumental variables. If
the Wald test indicates a failure of exogeneity, instrumental variables are lagged until the
23
test yields an insignificant statistic (the visible result is that the German inflation rate is
lagged in the first-stage regression of the model predicting the Japanese tariff as a
function of the German tariff). Details of the procedures, along with instrument lists for
each of the 2SLS equations, are provided in the appendix.
In addition to the 2SLS results, I also report results of ordinary-least-squares (OLS)
regressions for each of the six equations. The reason is that the endogeneity problem in
these equations is, with one exception, not severe enough to conclude that 2SLS
estimators are superior to OLS estimators. Tests of the appropriateness of the two
estimators, reported in the appendix, fail in all but one case to reject the joint null
hypothesis that the OLS specification is appropriate and that the instrumental variables
are specified correctly. The exception is the model predicting the US tariff as a function
of the German tariff, where the 2SLS estimator is clearly superior.
Here, the theory implies that one of the explanatory variables (the foreign tariff) is
endogenous to the dependent variable (domestic tariffs). However, from the standpoint
of estimation, the endogeneity problem is in all but one case rather trivial. This is
important because 2SLS estimates can be better or worse than OLS estimates, even in the
presence of theoretical endogeneity in the explanatory variables. The reason is that 2SLS
estimators suffer from finite-sample bias, which becomes worse as the number of
instrumental variables grows larger or as the fit of the instrumental variables to the
endogenous explanatory variable grows poorer.23 Both the OLS and 2SLS estimates
23 Davidson and MacKinnon 1993: 209-42.
24
should therefore be interpreted together as tests of the hypothesis on international vs.
domestic effects on the tariff.
The results are reported in tables 2 through 4. Table 2 reports results for models of
the US tariff using both 2SLS and OLS specifications and including both Japanese and
German tariffs among the explanatory variables. The results demonstrate that both the
Japanese tariff and the German tariff are significant predictors of the US tariff, with
positive coefficients as expected. None of the remaining variables is significant, and
there are no marginal cases of almost-significant predictors among the standard
endogenous-protection variables. These results are common across 2SLS and OLS
regressions. Since equations 2 and 4 exhibit heteroskedasticity, White heteroskedasticity-
consistent standard errors are reported for these equations.
Table 3 reports results of models of the Japanese tariff. The US tariff is highly
significant, with a positive coefficient, in both 2SLS and OLS models. The effect of the
German tariff is not significant in the 2SLS equation but is significant at the 0.06 level in
the OLS regression. All but one of the endogenous-protection variables are insignificant
in all equations; the exception is inflation, which is significant in one of the OLS models
(equation 7). Equations 6 and 8 exhibit heteroskedasticity; White standard errors are
reported for these equations.
In models of the German tariff, a dummy variable is included for the year 1964. This
is done in order to take account of the jump in the tariff series (discussed above) that
25
Table 2. Dependent variable= ∆US tarifft 1953-1994
2SLS Estimates OLS Estimates
(coefficients inboldface type aresignificant at the0.05 level)
Equation 1coefficient(standard error)prob > |t|
Equation 2**coefficient(standard error)prob > |t|
Equation 3coefficient(standard error)prob > |t|
Equation 4**coefficient(standard error)prob > |t|
Constant -0.048(0.072)0.51
0.053 (0.145)0.72
-0.042(0.070)0.55
0.013(0.085)0.88
∆Inflationt-1 0.021(0.014)0.14
0.012(0.029)0.67
0.016(0.012)0.21
-0.009(0.019)0.63
∆Unemploymentt-1 0.014(0.049)0.78
0.114(0.084)0.19
0.024(0.047)0.61
0.098(0.059)0.11
∆GDP growth ratet-1 -0.007(0.015)0.65
0.028(0.198)0.71
-0.004(0.015)0.79
0.020(0.018)0.27
President t-1 -0.057(0.096)0.55
0.015(0.198)0.71
-0.066(0.094)0.49
-0.107(0.132)0.42
Congress t-1 0.233(0.199)0.25
0.320(0.274)0.25
0.224(0.195)0.26
0.207(0.250)0.41
Split Congress t-1 0.097(0.127)0.45
0.015(0.162)0.92
0.093(0.125)0.46
0.054(0.644)0.64
∆Japanese tariff t-1 0.496(0.097)<0.0001
0.431(0.063)<0.0001
∆German tariff t-1 0.804(0.318)0.02
0.231(0.115)0.05
adjusted R2 * * 0.56 0.073
F 5.43<0.001
0.980.46
8.50<0.0001
1.460.21
Durbin-Watson 1.94 2.05 1.92 1.66
* R2 is not interpretable in 2SLS models ** White heteroskedasticity-consistent standard errors
26
Table 3. Dependent variable = ∆Japanese tarifft 1953-1994
2SLS Estimates OLS Estimates
(coefficients inboldface type aresignificant at the0.05 level)
Equation 5coefficient(standard error)prob > |t|
Equation 6**coefficient(standard error)prob > |t|
Equation 7coefficient(standard error)prob > |t|
Equation 8**coefficient(standard error)prob > |t|
Constant 0.130(0.088)0.15
0.022(0.151)0.88
0.07(0.070)0.26
0.056(0.100)0.58
∆Inflationt-1 -0.016(0.012)0.21
-0.038(0.026)0.16
-0.025(0.010)0.01
-0.033(0.020)0.10
∆Unemploymentt-1 0.227(0.278)0.42
0.216(0.248)0.39
0.207(0.222)0.36
0.266(0.209)0.21
∆GDP growth ratet-1 -0.0009(0.003)0.76
-0.002(0.003)0.52
-0.001(0.002)0.66
-0.004(0.003)0.20
∆LDP share t-1 -0.025(0.017)0.16
0.0008(0.017)0.96
-0.016(0.014)0.25
0.003(0.016)0.85
∆US tariff t-1 2.254(0.298)<0.0001
1.402(0.187)<0.0001
∆German tariff t-1 0.218(0.578)0.71
0.487(0.249)0.06
adjusted R2* * 0.64 0.21
F 14.35<0.0001
1.990.10
15.80<0.0001
3.220.02
Durbin-Watson 2.00 1.91 2.06 1.89
* R2 is not interpretable in 2SLS models** White heteroskedasticity-consistent standard errors
27
Table 4. Dependent variable = ∆German tarifft 1953-1994
2SLS Estimates OLS Estimates
(coefficients inboldface type aresignificant at the0.05 level)
Equation 9**coefficient(standard error)prob > |t|
Equation 10**coefficient(standard error)prob > |t|
Equation 11**coefficient(standard error)prob > |t|
Equation 12coefficient(standard error)prob > |t|
Constant 0.047(0.097)0.63
0.016(0.069)0.82
-0.032(0.072)0.66
-0.066(0.072)0.37
∆Inflationt-1 -0.026(0.031)0.41
-0.014(0.029)0.63
-0.032(0.028)0.27
-0.020(0.021)0.36
∆Unemploymentt-1 -0.032(0.102)0.76
-0.066(0.095)0.50
-0.077(0.090)0.40
-0.075(0.082)0.37
∆GDP growth ratet-1 0.022(0.029)0.46
-0.005(0.024)0.85
0.008(0.026)0.76
0.003(0.024)0.91
∆CDU/CSU share t-1 -0.054(0.034)0.12
-0.016(0.022)0.48
-0.018(0.026)0.51
-0.011(0.022)0.61
1964 dummy -1.672(0.11)<0.0001
-5.167(3.955)0.20
-1.705(0.082)<0.0001
-1.662(0.46)<0.001
∆US tariff t-1 1.571(0.61)0.01
0.520(0.147)0.001
∆Japanese tariff t-1 0.337(0.103)<0.01
0.28(0.102)<0.01
adjusted R2* * 0.32 0.33
F 3.59<0.01
3.48<0.01
4.16<0.01
1.92<0.01
Durbin-Watson 1.97 1.81 2.18 2.07
* R2 is not interpretable in 2SLS models** White heteroskedasticity-consistent standard errors
28
results from selection of a given year (here, 1965) as the initial year of the European
Common Market. The results for the German tariff, reported in Table 4, resemble those
for the US tariff: both of the foreign tariffs have significant positive effects, while none
of the remaining variables is significant (save for the 1964 dummy). As in the US case,
these results are common across 2SLS and OLS regressions. Three of the equations
exhibit heteroskedasticity (equations 9, 10, and 11) and are reported using White standard
errors.
These results provide clear evidence of interaction among the tariffs of the United
States, Japan, and the European Community. Virtually no evidence is found to support
the claims of endogenous protection models linking domestic-level political and
economic variables to the tariff (the lone exception is in the case of Japan, where inflation
appears as a significant predictor of the tariff in one of the OLS equations). Still, in light
of the theory developed above, some care should be used in interpreting the results,
especially those regarding partisan effects. At the theoretical level, there is no reason to
expect that macroeconomic conditions exert systematic, unidirectional effects on the
demand for protection or on the willingness of governments to supply it. The empirical
tests reported in this section can be interpreted as largely rejecting the endogenous-
protection hypothesis relating macroeconomic conditions to the tariff.
Partisan effects, while weakened under negotiated trade policy, are not theoretically
extinguished by it. Partisan influences on the tariff may accumulate over time in a way
that is not perceptible in the systematic lag structure of a regression equation; thus, the
29
empirical results offer somewhat weaker evidence for the absence of partisan effects. For
purposes of the argument developed above, however, the evidence is fairly conclusive.
Endogenous-protection models of the tariff do not survive hypothesis tests against the
theory that the tariffs of the major trading states respond mainly to each other, through
the negotiation process of the GATT/WTO.
Conclusion: tariffs, institutions, and trade policy
The political pressures that influence the tariff have long been of interest in political
economy. Research on the subject has blossomed during the past two decades, due in no
small part to the systematic approach offered by endogenous protection theory. Most
endogenous-protection models, though, have been drawn against a political background
that no longer exists in the major trading states: a domestic-level market for protection
isolated from international politics. The omission of international-level influences has
led to misspecification of political models of tariff formation and to unwarranted
inferences about the effects of macroeconomic and political variables on trade policy.
Developing an accurate model of variation in the tariff is not in itself of fundamental
importance; there is no grave need for a technique that predicts variation in industrial-
country tariffs now standing at something less than 3% on average. Models of trade
policy are useful instead as a means of gaining insight into the political processes that
they represent. At issue in this article is the ability of an international institution to
30
intervene in domestic-level political processes that, left to themselves, yield reliably
deficient outcomes. The results reported here lend credence to the possibility of this type
of intervention. Negotiated trade policy under the GATT/WTO has transformed trade
politics by incorporating international influences and pro-liberalization interest groups
into domestic-level political competition. In doing so it has tied the tariffs of the major
trading states to each other and weakened their connection to traditional indicators of the
demand for protection.
A theory based on the effects of institutionalized negotiation is not the only account
that can be given of postwar trade liberalization. Other explanations focus on ideological
change24, resistance to protection by multinational corporations,25 security alliances
among trading partners,26 or, at further remove, hegemonic stability,27 class coalitions
and regime types,28 and the systemic distribution of capabilities.29 Indeed, Marx of The
Communist Manifesto would instantly recognize a period of trade liberalization––the
destruction of protectionist walls to institute "the one unconscionable freedom"––as an
imperative of capitalist reproduction.
While these broad-gauged theories can account for the interests supporting trade
liberalization, they are several steps away from explaining the political process that
24 Goldstein 1993.25 Milner 1988.26 Gowa and Mansfield 1993.27 Gilpin 1975; Kindleberger 1986; Krasner 1976.28 Rogowski 1989; Verdier 1998.29 Mansfield 1994.
31
causes variation in the tariff. Interests alone do not bring about policy changes, and in
particular they do not resolve the domestic- and international-level collective action
problems that stand in the way of free trade. Broad-gauged theories identify permissive
conditions for trade liberalization without specifying the political mechanisms that bring
it into existence. Though perhaps a strength for the theories' own purposes, this is an
equally great weakness for analysis of the short-term political influences on trade policy.
The political mechanisms that make trade liberalization possible are worthy of
analysis for reasons beyond theory. Endogenous protection theory, responsible for the
best existing models of annual variation in the tariff, draws seemingly credible
connections between macroeconomic conditions and trade protection. In a nutshell, the
theory claims that good economic performance leads to trade liberalization and poor
economic performance to protection. This suggests that trade policy is chained to the
business cycle and that institutions such as the GATT/WTO can do little more than add
friction to the domestic-level causal processes that determine it. If, as I have argued,
institutionalized negotiations can intervene in these domestic-level processes, then the
potential for trade liberalization through international institutions is much greater:
institutions can unchain trade policy from the business cycle and bring about
liberalization despite periods of poor economic performance.
The analysis here has been confined to a single trade policy instrument (tariffs),
rather than to the full range of devices that can be used for protectionist purposes. The
main reason is that data on non-tariff barriers (NTBs) are not adequate for assessing the
32
relative effect of international and domestic effects on protection. The best data source
for NTBs, the United Nations Conference on Trade and Development's NTB inventory,
covers only a short time period and provides little more than a tally of the incidence of
NTBs across industries in a sample of countries.30 Mansfield and Busch put these data to
work in an interesting analysis of statist vs. societal influences on NTBs,31 but data
limitations allow them a sample size of only twenty-eight (a panel of fourteen states
observed in 1983 and 1986) in a model including twelve independent variables. While
such a sample may be appropriate for Mansfield and Busch's purposes, it is clearly
inadequate for the analysis of trade policy interaction across states over time.
The argument developed here suggests that a reconsideration of research on NTBs is
in order. Whether statist or societal in origin, NTBs are commonly depicted as the result
of demands for protection originating at the domestic level. In a narrow sense, this is
definitionally true, but it is misleading as a model of variation in non-tariff barriers to
trade. Industrial-country NTBs typically emerge not merely in response to general
demands for protection, but as measures designed to counteract foreign subsidies or other
export-promoting policies. Agricultural NTBs arose in a context of heavily subsidized
production worldwide.32 The various quota schemes on textiles and apparel culminating
in the Multi-Fiber Arrangement (MFA) were likewise responses to subsidization by new
30 United Nations Conference on Trade and Development 1993: 39-48.31 Mansfield and Busch 1995.32 Dam 1970: 258; General Agreement on Tariffs and Trade 1962: 135 ff.
33
entrants into export markets for these commodities.33 Voluntary export restraints (VERs)
on automobiles, quotas and price floors on steel, market-share arrangements on computer
chips, and most other major NTBs resulted not simply from domestic-level protectionist
pressure but in response to subsidization, state-sponsored dumping, and infant-industry
protection by exporting countries.34 Like tariffs, contemporary industrial-country NTBs
are determined in a political context that includes both domestic and international
influences.
Non-tariff barriers respond not only to policies in exporting countries, but also to each
other. The American voluntary export restraint (VER) on Japanese automobiles led
quickly to similar measures by Canada and the European Community.35 The Multi-Fiber
Arrangement began in 1957 as an American VER on Japanese cotton textiles; within five
years the US was joined by the EC and other European countries in a multi-party system
of import quotas.36 In the 1970s and 1980s, the United States and the EC devised NTBs
on steel that clearly took account of each other's import restrictions; Hufbauer, Berliner,
and Elliott refer to the US and European steel NTBs as a "nascent multi-steel
arrangement."37
More important for the thesis of this article is that NTBs respond to each other in the
trade-liberalizing direction as well as the protectionist one. The Tokyo Round of GATT
33 Hufbauer, Berliner and Elliott 1986; Yoffie 1983.34 Nivola 1993; Levine 1985: 1-25; Crandall 1981: 1-45; Hufbauer, Berliner, and Elliot 1986.35 Jones 1994.36 Yoffie 1983: 43-160.37 Hufbauer, Berliner, and Elliott 1986: 170.
34
negotiations addressed several categories of NTBs, resulting in optional side agreements
that are generally viewed as failures.38 The Uruguay Round negotiations, though,
revisited these issues and, with one major exception (antidumping), effectively resolved
them. The terms of the agreement include tariffication of agricultural NTBs and
elimination of the Multi-Fiber arrangement, along with strengthened rules governing
subsidies, technical barriers to trade, so-called safeguards (including VERs) and several
other types of non-tariff measures. Just as importantly, the negotiations produced much-
strengthened adjudication and enforcement procedures capable of ensuring compliance
with the NTB agreements.39
Trade barriers in any form are political devices designed to satisfy domestic-level
demands; to suggest otherwise would be plainly mistaken. Explaining contemporary
trade barriers without reference to the international politics of trade, though, is at odds
with both logic and evidence. Among the major trading states, trade policy is not
determined in a domestic-level vacuum. Connections between domestic and foreign
trade policy are predictable, explicit, and largely institutionalized. As a result, the
demand for protection is but one of the varieties of pressure brought to bear on states'
trade policies, and protectionist interests must face free-trading interests in a political
contest biased toward liberalization.
38 Grieco 1990; Preeg 1995: 24-27.39 See Organisation for Economic Cooperation and Development 1994; Preeg 1995.
35
The GATT, an institution based rather unabashedly on the self-interest of states, has
proved more successful than seemed likely at its inauguration. The GATT's success
appears to owe less to the specific legal structure that it has imposed on trade than to the
mere fact of its existence. By providing an international market for the exchange of trade
barriers, the institution has undermined domestic-level political markets for protection
and has motivated exporters to demand negotiated liberalization. Through this
mechanism, the institution has internationalized the politics of trade.
36
Appendix: data sources and econometric procedures
Data sources
Tariffs are measured as 100 × customs revenue divided by imports (f.o.b.) in local
currency at current prices. Through 1988, US customs data are taken from B. R.
Mitchell, International Historical Statistics: The Americas 1750-1988 (New York:
Stockton Press, 1993), Japanese customs data from B. R. Mitchell, International
Historical Statistics: Africa, Asia, and Oceania 1750-1988 (New York: Stockton Press,
1995), and German customs data from B. R. Mitchell, International Historical Statistics:
Europe 1750-1988, 3rd edn. (New York, Stockton Press, 1992). After 1988, customs data
are taken from Organization for Economic Cooperation and Development, Revenue
Statistics 1965-1996 (Paris: OECD, 1997). Data on imports are taken from International
Monetary Fund, International Financial Statistics Yearbook (Washington, DC:
International Monetary Fund, 1979 and 1995). German tariff data require disaggregating
German imports into EC and non-EC imports. Data on German imports from EC
members are taken from International Monetary Fund, Direction of Trade Statistics
Yearbook (Washington, DC: International Monetary Fund, various years) and converted
to local currency using average annual exchange rates taken from International Monetary
Fund, International Financial Statistics Yearbook (Washington, DC: International
Monetary Fund, 1979 and 1995).
37
Inflation is calculated as the annual percentage change in the producer price index.
These data are taken from International Monetary Fund, International Financial Statistics
Yearbook (Washington, DC: International Monetary Fund, 1979 and 1995).
GDP is measured in local currency at 1990 prices. For Japan, GNP is used rather than
GDP due to data limitations. The data are taken from International Monetary Fund,
International Financial Statistics Yearbook (Washington, DC: International Monetary
Fund, 1979 and 1995).
Unemployment is measured as the civilian unemployment rate. Through 1959, US
unemployment data are taken from Economic Report of the President (Washington, DC:
US Government Printing Office), various years; Japanese unemployment data are taken
from Nihon Tokei Nenkan (Japan Statistical Yearbook) (Tokyo: Sorifu, Tokeikyoku,
various years), and German unemployment data from B. R. Mitchell, International
Historical Statistics: Europe 1750-1988, 3rd edn. (New York, Stockton Press, 1992).
After 1959, unemployment data are taken from Organisation for Economic Cooperation
and Development, Main Economic Indicators (OECD: Paris, various years).
Political variables differ across countries and are explained in the text. For the United
States, data are taken from US Department of Commerce, Historical Statistics of the
United States (Washington, DC: US Government Printing Office, 1975); Harold Stanley
and Richard Niemi, Vital Statistics on American Politics (Washington, DC:
Congressional Quarterly Press, 1988), and Arthur S. Banks et al. (eds), Political
Handbook of the World: 1995-1996 (Binghamton, NY: CSA Publications, 1996). For
38
Japan, data are taken from Jaap Woldendorp and Chris Cook, The Facts on File Asian
Political Almanac (New York: Facts on File, 1994) and Arthur S. Banks et al. (eds),
Political Handbook of the World: 1995-1996 (Binghamton, NY: CSA Publications,
1996). The seat shares of the Liberal and Democratic parties are combined prior to 1956
to form the LDP seat share figure. For Germany, data are taken from Jaap Woldendorp et
al., Handbook of Democratic Government: Party Government in 20 Democracies (1945-
1990) (Dordrecht: Kluwer Academic Publishers, 1993), and Arthur S. Banks et al. (eds),
Political Handbook of the World: 1995-1996 (Binghamton, NY: CSA Publications,
1996).
Econometric procedures
This section reports goodness-of-fit statistics for regressions of the endogenous
explanatory variables (foreign tariffs) on the instrumental variables, tests of the
exogeneity of the dependent variables to the instrumental variables, and tests of
overidentifying restrictions on the 2SLS models. For brevity I describe each test first and
then collect the results in a table.
For convenience, I refer to the dependent variables (domestic tariffs) as y, the
exogenous explanatory variables as x (with coefficient vectors βx), the endogenous
explanatory variables as z (with coefficients βz), and the instrumental variables as w (with
coefficient vectors βw). Instrumental variables w, listed by equation, are as follows:
39
Equation Instrumental variables
1 ∆Japanese tariff(t-1), ∆Japanese inflation, ∆Japanese imports
2 ∆German tariff(t-1), ∆German inflation, ∆German imports
5 ∆US tariff(t-1), ∆US inflation, ∆US imports
6 ∆German tariff(t-1), ∆German inflation(t-1), ∆German imports
9 ∆US tariff(t-1), ∆US inflation, ∆US imports
10 ∆Japanese tariff(t-1), ∆Japanese inflation, ∆Japanese imports
The goodness-of-fit statistics are unadjusted R2 statistics for regressions of the
endogenous explanatory variables on x and w. The purpose of these first-stage
regressions is to maximize R2 while not including too many instrumental variables and
while insuring the exogeneity of domestic tariffs to the instrumental variables.
The exogeneity tests are derived from the models y = β0 + βxx + βzz + βww + ε, where
β0 is the constant term. They are Wald tests of the hypothesis that all the elements of βw
are equal to zero. The test results include an F statistic and a chi-squared statistic.
Rejection of the null hypothesis indicates that the dependent variable is endogenous to
the instrumental variables.
The 2SLS models are overidentified, since there are more instrumental variables than
endogenous explanatory variables. The tests of overidentifying restrictions are tests of
the joint null hypothesis that the OLS specification is appropriate and that the
40
instrumental variables are specified correctly; more simply, they are tests of the
hypothesis that the equations can be estimated efficiently by OLS regression. The tests
are conducted as follows: first, z is regressed on x and w, yielding residuals u. Then, the
following model is estimated: y = β0 + βxx + βzz + γu + ε. The test of overidentifying
restrictions is a test of the hypothesis that γ = 0. If the test yields a significant statistic,
then the 2SLS specification is clearly preferred to the OLS specification. If not, the OLS
specification is admissible.
41
Table 5. Goodness-of-fit statistics, exogeneity tests, and tests of overidentifying restrictions in 2SLSequations
Equation
Goodness-of-fit statistics
(R2 of regressions of z on w)
Exogeneity tests (equations y=β0 + βxx + βzz + βww + ε;Η0: βw = 0)
F χ2
prob>F prob> χ2
Tests of overidentifyingrestrictions (estimates of γin equations y = β0 + βxx +βzz + γu + ε)
γ (standard error)prob > |t|
1 .59 2.12 6.360.12 0.10
-0.113 (0.127)0.38
2 .20 1.80 5.400.17 0.14
-0.653 (0.319)0.05
5 .24 0.38 1.140.77 0.77
-0.476 (0.478)0.33
6 .26 1.61 4.820.21 0.19
0.303 (0.652)0.65
9 .33 1.91 5.740.15 0.13
-0.374 (0.533)0.49
10 .50 1.46 4.390.24 0.22
0.102 (0.239)0.63
42
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