Domestic political competition and pro‐cyclical import protection

• DOI: http://doi.org/10.1111/roie.12223
• Date: 01 August 2016
• Author: Maia Linask,James Lake
• Published date: 01 August 2016

Domestic Political Competition and Pro-cyclical

Import Protection

James Lake and Maia Linask*

Abstract

Governments, especially in developing countries, routinely practice binding overhang (i.e. setting applied tariffs

below binding WTO commitments) and frequently move applied tariffs for given products up and down over

the business cycle. Moreover, applied tariffs are pro-cyclical in developing countries. We explain this phenom-

enon using a dynamic theory of lobbying between domestic interest groups. Applied tariffs are pro-cyclical when

high-tariff interests (e.g. import-competing industries) capture the government: these groups concede lower tariffs

to low-tariff interest groups (e.g. exporting firms or firms using imported intermediate inputs) during recessions

because recessions lower the opportunity cost of lobbying and thereby generate a stronger lobbying threat.

1. Introduction

A striking feature of WTO tariff agreements is the lack of commitment to specific tariff

levels. Rather, countries commit to upper bounds on tariffs which are known as tariff bind-

ings. As such, countries retain flexibility when setting actual tariffs which are known as

applied tariffs. A country does not violate its WTO commitments by unilaterally raising its

applied tariffs as long as they remain below the tariff binding. Recent papers (e.g. Nicita

et al. (2013) and Beshkar et al. (2015)) have begun to empirically document the widespread

phenomenon of “binding overhang” whereby countries set applied tariffs below tariff bind-

ings. This is especially true in developing countries where tariff bindings often far exceeded

applied tariffs after the 1994 Uruguay Round (Bchir et al. (2006) and Nicita et al. (2013)).

Moreover, Lake and Linask (2015) document that developing countries often use this

greater flexibility by moving the applied tariff for a given product up and down over time.

While recent work has analyzed the theoretical and empirical determinants of applied tar-

iffs and binding overhang (Bown and Crowley (2013b), Ludema and Mayda (2013), Nicita

et al. (2013) and Beshkar et al. (2015)), these studies have ignored the role of the business

cycle. Indeed, conventional wisdom views applied tariffs as counter-cyclical, rising in reces-

sions (creating lower binding overhang) and falling in booms (creating higher binding over-

hang).

1

Nevertheless, using data for over 5,000 products in 72 developed and developing

countries for 2000–2011, Lake and Linask (2015) find pro-cyclical applied tariffs and, thus,

counter-cyclical binding overhang.

2

Moreover, they find that these results are completely

driven by developing countries, with applied tariffs being acyclical in developed countries.

In this paper, we present, to the best of our knowledge, the first theoretical model

attempting to explain the pro-cyclical applied tariffs and the counter-cyclical binding

overhang empirically observed in developing countries. In our setup, the government is

* Lake: Department of Economics, Southern Methodist University, 3300 Dyer Street, Suite 301,

Umphrey Lee Center, Dallas, TX 75275. E-mail: jlake@smu.edu. Linask: Robins School of Business,

University of Richmond, 28 Westhampton Way, Richmond, VA 23173. E-mail: mlinask@richmond.edu.

We would like to thank two anonymous referees for helpful comments, Kamal Saggi for discussant com-

ments on an earlier version of this paper, Mostafa Beshkar, Peri da Silva, and conference participants at

the Fall 2012 Midwest Trade Meetings and the 2012 Texas Theory Camp.

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C2016 John Wiley & Sons Ltd

Review of International Economics, 24(3), 564–591, 2016

DOI:10.1111/roie.12223

captured by either high-tariff interests (e.g. import-competing firms) or low-tariff inter-

ests (e.g. firms that export and/or use imported intermediate inputs) and implements

the nominated applied tariff of the group by whom it is captured.

3

In each period, the

incumbent group, i.e. the group who has captured the government and is dictating

applied tariffs, faces the threat of displacement as a result of lobbying by the opposing

group. To mitigate this lobbying threat, an incumbent group may nominate an applied

tariff different from the ideal tariff it would implement absent any lobbying threat.

Counter-cyclical binding overhang and pro-cyclical applied tariffs emerge in equilibrium

when high-tariff interests are the incumbent group. Driving this result is the time-varying

opportunity cost of lobbying. Intuitively, using scarce resources for lobbying is more attrac-

tive during recessions because recessions are associated with negative productivity shocks or

low prices via low aggregate demand, and these forces depress the marginal revenue product

of resources used in production. Given this pro-cyclical opportunity cost of lobbying, reces-

sions produce a stronger lobbying threat from the opposing group. To preemptively mitigate

the stronger lobbying threat of the opposing group during recessions, the incumbent group

makes concessions by moving the applied tariff away from its own ideal tariff and toward

the ideal tariff of the opposing group. That is, applied tariffs are pro-cyclical and binding

overhang is counter-cyclical when high-tariff interests are the incumbent group dictating tar-

iff policy. Conversely, applied tariffs are counter-cyclical and binding overhang is pro-

cyclical when low-tariff interests are the incumbent group. Thus, our results are consistent

with the view that high-tariff interests have a dominant influence over tariff policy.

Motivated by the seminal work of Krueger (1974), Bhagwati (1982) and Acemoglu

and Robinson (2001), the core version of our model assumes that lobbying by the

opposing group destroys a fraction of the economy’s resources. We extend the model

to allow high-tariff and low-tariff interests to simultaneously and strategically choose

an amount of labor for lobbying with the residual labor used to produce output. Here,

recessions not only affect economic output directly but also indirectly via the endoge-

nous allocation of labor between production and lobbying. Nevertheless, the key

insight remains: the opportunity cost of lobbying is lower during recessions than

booms and, therefore, tariffs are pro-cyclical when high-tariff interests dictate tariff

policy. Thus, our results extend to different formalizations of lobbying; the key feature

is the pro-cyclical opportunity cost of lobbying.

More broadly, the idea that the opportunity cost of initiating conflict is lower when eco-

nomic conditions are less favorable is deeply rooted in the civil war literature. For example,

Blattman and Miguel (2010, p.12) argue that “Their [Chassang and Padro-i Miquel (2009)]

key insight is that transient economic shocks increase the immediate incentives to fight but

not the discounted present value of victory. The model thus implies that in dire economic

circumstances groups predate upon one another since they have less to lose than in periods

where the returns to production are higher.” Blattman and Miguel (2010) also discuss sup-

porting empirical evidence including Collier and Hoeffler (2004) and Miguel et al. (2004).

Because the central mechanism we propose is that the group in control of tariff setting

manipulates tariffs to pre-emptively avoid opposition lobbying, lobbying does not arise in

the equilibrium of our model. Of course, superficial anecdotal evidence suggests lobbying

is a pervasive phenomenon. However, in a comprehensive review of the empirical lobby-

ing literature, de Figueiredo and Richter (2014, p.178) argue that important directions for

future research include understanding “Why is there so little money in lobbying” and

“... why do so few interest groups lobby.” Our model suggests that part of the answers

may be that interest groups who exert dominant influences over policy are willing to

cede ground when facing a strong latent lobbying threat by opposition groups.

DOMESTIC LOBBYING AND PRO-CYCLICAL TARIFFS 565

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C2016 John Wiley & Sons Ltd