Policy Choice: Theory and Evidence from Commitment via International Trade Agreements

Abstract

Why do governments employ inefficient policies to redistribute income towards special interest groups (SIGs) when more efficient ones are available? To address this puzzle we derive and test predictions for a set of policies where detailed data is available and an efficiency ranking is feasible: tariffs vs. non-tariff barriers (NTBs). In our policy choice model a government bargaining with domestic SIGs can gain by constraining tariffs through international agreements even if this leads to the use of the less efficient NTBs. This generates two key testable predictions (i) there is imperfect policy substitution, i.e. tighter tariff constraints are not fully offset by the higher NTBs they generate and (ii) the decision to commit to constraints depends on the government's bargaining power relative to SIGs. Using detailed data, we confirm that tariff constraints in trade agreements increase the likelihood and restrictiveness of NTBs. We also provide a structural estimate that indicates NTBs are less efficient than the tariffs they imperfectly replace. Moreover, we find parametric and non-parametric evidence that the higher the government bargaining power relative to a SIG the more relaxed the tariff constraint it chooses. This result is stronger for organized industries, which further supports the theory. The main theoretical insights and empirical approach can be applied to other policies to provide additional evidence on inefficient redistribution.

Are nontariff measures and tariffs substitutes? Some panel data evidence

“…It also gives greater credibility to any causal interpretation of the impact of lagged tariffs on the AVE of NTMs, in particular in the context of political economy processes and administrative implementation of adjustments in NTMs that can be expected to take time. This is in contrast to existing studies that have confined their estimation to one point in time (see Kee et al, ; Lee & Swagel, ; Limão & Tovar, ; Ronen, ), or eschewed the kind of dynamic aspects of policy adjustment that a panel framework allows…”

“…Although a significant number of studies find trade policy substitution between tariffs and NTMs, this finding is sometimes weak and found mostly for developing countries. Further a number of studies identify a heterogeneous relationship determined by country or product characteristics (Beverelli, Boffa, & Keck, ; Bown & Tovar, ; Broda, Limão, & Weinstein, ; Feinberg & Reynolds, ; Herghelegiu, ; Kee, Nicita, & Olarreaga, ; Ketterer, ; Limão & Tovar, ; Moore & Zanardi, ; Orefice, ; Ronen, ; WTO, ). Indeed, a few studies identify a significant complementary relationship between the two trade policy instruments (Dean, Signoret, Feinberg, Ludema, & Ferrantino, ; Goldberg & Pavcnik, ; Lee & Swagel, ; Trefler, ).…”

“…In effect, much of this literature focuses on the “incidence” of NTMs to establish the NTM–tariff link, where they estimate how tariffs affect the probability of NTMs being deployed (see Beverelli et al, ; Feinberg & Reynolds, ; Herghelegiu, ; Ketterer, ; Limão & Tovar, ; Moore & Zanardi, ; Orefice, ), or the extent of NTMs through frequency and coverage ratios (see Broda et al, ; Lee & Swagel, ; WTO, ). The studies by Kee et al (), Limão and Tovar () and Ronen () are rare examples that use tariff equivalents of NTMs. However, as outlined below, an important limitation facing these studies is the absence of information on NTMs over time and the associated constraint of having to model the NTM–tariff relationship in cross‐section only.…”

A Bargaining Theory of Inefficient Redistribution Policies

“…Any given industry (or other type of SIG) also discounts the future more heavily in countries with poor protection of property rights where they are more likely to accept 30 Limão and Tovar-Rodriguez (2007) provide a theoretical and empirical analysis of the choice between tariffs and NTBs that builds on our framework. If a SIG represents an industry i then the government's bargaining power relative to it, γ i , is higher if that industry is new, dying, or more generally faces very uncertain times-so that the probability of remaining in business in the absence of government transfers is small.…”

Preferential Liberalization, Antidumping, and Safeguards: Stumbling Block Evidence from MERCOSUR

“…This paper also contributes to a related literature on the intertemporal substitution of different trade policy instruments that may be arising due to a variety of different types of shocks. For example, Limão and Tovar () study Turkey's trade policy substitution away from tariffs and toward a broad class of non‐tariff barriers in response to its accession to the WTO in 1995 and its formation of a customs union with the European Union. Bown and Tovar () use the “exogenous” shock of India's MFN tariff liberalization in the early 1990s to examine its policy substitution toward antidumping and safeguards (TTBs) using the Grossman and Helpman () protection for sale framework.…”