Evidence for the Tariff‐Lobbying Paradox: Endogenous Tariffs Fall as Protectionist Lobbying Rises Stephen Magee1 Department of Finance University of Texas at Austin Hongshik Lee2 Department of Economics Korea University JunYun Kim3 Department of Economics Korea University June 2016
There is casual empirical evidence from the United States in recent years that protectionist lobbying expenditures were rising while U.S. tariff rates were falling. This paper explores whether this potential paradox also appears using data from 15 industries and 27 countries between 1995 and 2009. Because of an absence of country lobbying data, we use the Young and Magee (1986) general equilibrium endogenous tariff model plus actual country tariff data to generate predicted income maximizing pro‐and anti‐tariff lobbying ratios. From this cross‐country data, we find two effects consistent with the paradox. First, actual country tariff rates drop as country capital labor‐ratio endowments rise because of the increasing economic and political unimportance of labor, the protectionist factor of production. Second, as capital – labor ratios rise across industries with economic development, we observe rising magnification effects of tariffs on real wages, a result from international trade theory. The latter appear to be sufficiently strong to increase protectionist lobbying even with decreases in actual tariffs. JEL classification: F13, D72 Key Word: Paradoxes, Lobbying, Trade protection, Tariffs, Rent seeking 1
University of Texas at Austin, Austin, TX 78712,[email protected]
Corresponding author, [email protected]; Department of Economics, Korea University Anam‐dong, Sungbuk‐gu, 136‐705, Republic of Korea
3
[email protected]; Department of Economics, Korea University
2
1 1. Introduction By demonstrating that political and economic characteristics are possible determinants of tariff rates, the endogenous tariff model made it possible for researchers to investigate the determinants of trade policies. Brock and Magee (1978) provided the first model of endogenous protection with both tariffs and lobbying in endogenous. Findlay and Wellisz (1982) provided the first model for endogenous lobbying in general equilibrium, and Mayer (1984) followed with a model of tariffs with endogenous voters. Young and Magee (1986) constructed the first 2x2x2x2 full general equilibrium model with tariffs, lobbying, and political party success all endogenous with two goods, two factors, two lobbies and two political parties.4 The “Protection for Sale" paper by Grossman and Helpman (1994) [hereafter, GH], provided a model in which parties would balance lobbying resources against maximized social welfare.5 The implication of this model is that, protection is determined by a policy game between stakeholders and the government.6 The equilibrium level of trade protection in a certain industry is affected by political organization, import dependence, and the import elasticity in that industry. Later, many empirical studies attempted to test the GH model using data in various countries. Using U.S. tariff data, Goldberg and Maggi (1999) showed that trade barriers increase as industrial import penetration and import elasticity increase and, most importantly, lobbying by stakeholders in specific industry have a non‐negligible influences on the government’s trade policymaking. Grether et al.(2001), also, conducted an empirical analysis of the GH model using data from Mexico.7 These studies that rely on the GH model, however, merely address the importance of lobbying in determining the level of trade protection. Many followup studies have attempted to overcome this limitation by considering both country and industrial characteristics in the model. Two of the most notable studiess are Gawande and Bandyopadhyay (2000) and Esfahani (2005). Using U.S industrial data, Gawande and Bandyopadhyay (2000) showed that the tariff rates on final goods are higher when those on intermediate goods are high, while Esfahani (2005) used a modified GH model that considers industrial characteristics and the possibility of trade retaliation to show that the level of trade protection is higher with fewer low‐skilled workers, and a higher possibility of trade retaliation. The existing GH literature on lobbying, as explained above, generally concludes that protection increases with lobbying from import competing industries. However, there is rising empirical evidence to the contrary. For example, the U.S. data in Figure 1 through time shows that tariff rates for manufactured goods have decreased despite the increasing protectionist 4
Important studies in this area including Bohara and Kaempfer (1991), Trefler (1993), Das and Das (1994), and Tombazaos (2003), all of whom attempted various empirical approaches to the endogenous tariff model. And also Gawande et al. (2006) found that there is a negative correlation between the strength of lobbying and trade barriers in the U.S, which is consistent with a causal link between lobbying and trade barriers.
5
In the political economy literature, we have two types of model. Magee et al. (1989) and Grossman and Helpman (1994) developed models with exogenous lobbying. Findlay and Wellisz (1982) and Rodrik (1986), however, assumed that lobbying was endogenous and that tariffs were a function of campaign contributions.
6
One of the well‐known merits of the Grossman and Helpman (1994) model is that it explains the interaction between policy makers and special interest groups that lobby for favorable policy decision.
7
Besides these studies, Eicher and Osang (2002) abd Facchini et al. (2006) also tested the GH model.
2 lobbying by interest groups. That figure relates lobbying for trade by political action committees (PACs) and average Most Favored Nation (MFN) tariff rates in the United States. Despite steadily increasing spending on lobbying, U.S. tariff rates have declined. This phenomenon is contrary to both expectations and the GH model. The paradox is that increased lobbying for protection should raise trade barriers but that does not appear to be the case. Then, how can we explain this paradox? One explanation not contemplated by either partial equilibrium models or GH is that both tariffs and lobbying are endogenous so there is no necessary negative correlation between the two in general equilibrium. The key to the puzzle is understanding the underlying drivers of both lobbying and tariffs. We have two primary explanations for the paradox of rising protectionist lobbying but decreasing tariffs as we examine cross‐section country data. The first explanation comes from Magee, Brock and Young. Tariffs protect labor and harm capital and the process of economic development is one of rising capital relative to labor. As the pro export factor capital grows relative to the protectionist factor labor, capital accumulates increasing political clout relative to labor. This is a primary driver of reduced tariff rates with economic development, a phenomenon we certainly observe in the data reported in this paper.8 There is a second and subtle general equilibrium reason why protection drops as lobbying increases with economic development. Since economic development results in capital – labor ratios rising in almost all industries, the ratios in the export industries become more similar to those in import – competing industries. We know from international trade theory that when the factor intensities of production in exportables and importables become more similar, the production possibility curve between them becomes flatter and this increases the magnification effect ‐‐ the responsiveness of factor prices to relative product prices. This increase in the magnification makes it possible for wages to increase even as tariff rates are falling. The reason is that even a smaller tariff can have a larger positive boost on real wages. Increased magnification also explains why labor is willing to devote increasing fractions of its resources to protectionist lobbying. We suggest that these two explanations are consistent with the timeseries evidence reported from the United States in Figure 1. It is also consistent with the advanced country cross‐section evidence of decreased actual tariff rates as country capital – labor ratios rise.9 These results contrast with the GH model, in which the level of trade protection increases as protectionist lobbying increases. This paper builds on initial insights from Magee, Brock and Young (1989), in which there is an increase in political activity with a decrease in the rate of return on economic activities. This paper is organized as follows. In Section 2 , we briefly describe a theoretical background for an increase in lobbying and a decrease in tariff accompanying a country’s economic growth and, in Section 3, we explain the empirical strategy and the data. We provide an interpretation of the main results in Section 4 and conclude the paper in Section 5 . 8
We deal in this paper only with countries whose production is capital‐intensive in exports relative to imports, the usual argument does not apply here that tariff rates decline with economic development because of less government dependence on tariff revenue relative to direct income tax revenue. 9
Labor groups’ participation in lobbying increases the likelihood of a pro‐trade protectionism party being reelected.
3 2. Theoretical Background In order to understand the tariff lobbying paradox, we employ the interest group model of endogenous tariffs and lobbying. This model captures the simultaneous interaction of economics, lobbying and politics.10 We use a theoretical structure based on Magee and Young (1986)’s endogenous policy model with two good, two factors, two lobbies and two political parties. They consider not only behavior of interest group also consider political party maximizing their winning change of election. They solve for the general equilibrium between two factor owners and two political parties. Both capital and labor lobby interest groups, maximize their utility while political parties maximize their probability of election, trading off general voter dissatisfaction with protection against the funding that favorable policies attract from the lobbies. This endogenous determination of the level of protection enables us to explain changes in lobbying expenditure when the exogenous parameters change. We can drive how lobbying activity and protection levels change when exogenous parameters change. In our study, the exogenous parameters, which influence both lobbying expenditure and protection level, work through magnification effects. Magnification is the responsiveness of the representative owners of capital and labor to the relative commodity price. To define the magnification, we assume the small economy where capital is the abundant factor relative to the trading partners. We also suppose that there are two goods in the country. First, good C is relatively capital‐intensive goods which country is export to other countries. Second good L is relatively labor‐intensive good which is import‐competing good. The country faces the exogenous is P
international price P , which is relative price of good C to good L ( P = L ) . PC
There are two domestic interest groups and political parties. The pro‐capital party is subsidizing S to the exports of capital‐intensive Good C , while the pro‐labor party is imposing tariff T on labor‐intensive good L . Each of domestic special‐interest policies generate trade distortions, then generate new domestic price Pd . Pd =
PL (1  t )
, PC (1  s )
(1) where s and t are the ad valorem export subsidy rate and ad valorem tariff rate respectively. Suppose that the production functions are Cobb‐Douglas and the unit cost functions of the two industries also can be written in the Cobb‐Douglas form, CC (r , w) = r  w1 and C L (r , w) = r  w1  , where  and  are constants such that 0 <  <  < 1 . Then the equilibrium factor price is as below.11 10
Findlay and Wellisz (1982) offer the first theoretical model of endogenous lobbying in general equilibrium by using ‘specific factor’ model used by Haberler, Ohlin, and Viner model. Also Mayer (1984) followed with a model of tariffs with endogenous voters.
11
The wage and rental rates are determined by the conditions for equilibrium in the two industries
4 w = ( Pd ) N and r = ( Pd )  M , N = /(   ) and M = (1   )/(   ) . (2)
Now, we suppose that the representative interest group of capital and labor are risk neutral and their utility function are Cobb‐Douglas functions and their indirect utility functions have the form Vr ( I r , Pd ) = I r ( Pd )  and Vw ( I w , Pd ) = I w Pd , (3) where 0   ,   1 . Let the K 0 and L0 the total endowment of capital and labor, and suppose representative interest group own all the endowment of capital and labor. Then representative pro‐capital interest group choose lobbying expenditure K and pro‐labor interest group choose lobbying expenditure L to lobbying. Therefore the utility of the capital interest group under domestic price Pd is Vr = ( K 0  K )( Pd )  m , where m = M   . Similarly, the utility of the labor interest group is Vw = ( L0  L)( Pd ) n , where n = N   . Since 0 <  <  < 1 and 0   ,   1 , we have m > 0 and n > 0 . ( K 0  K ) is fixed will yield the same utility for the capital interest group. Hence, ( Pd ) is similar to a cost of living index. Therefore, ( Pd )  m =
( Pd )  M
can be interpreted as the ( Pd )
‘real’ return to capital. Similarly, ( Pd ) n is the ‘real’ return to labor. This exogenous parameters m and n are respectively the elasticities of the real returns to capital and labor with respect to the commodity price Pd . With the capital and lobby equilibrium, the political party maximize their odds of election. We assume that theodds of election by the pro‐capital party is increased with the capital lobby and decreased with the level of tariff by pro‐labor party. Similarly, the odds of election by the pro‐labor party is increased with labor lobby and decreased with subsidy by pro‐labor party. Then the odds of election by the pro‐capital party can be expressed as following equation (4) by Theil (1971). =
KT
KT  LS
(4) Then, for the capital lobby, the representative capital interest group choose optimal K * ( L, S , T ) to maximize following equation (5). max g ( K ) = ( K 0  K )
K
0 K  K 0
KT ( P/S ) m  LS ( PT )  m
, ( KT  LS )
5 (5) while for the labor lobby, the representative labor interest group choose optimal L* ( K , S , T ) to maximize equation (6). [ KT ( P/S ) n  LS ( PT ) n ]
max f ( L) = ( L0  L)
. L
( KT  LS )
0 L  L0
(6) Since the pro‐capital party is a Stackelberg leader with respect to the capital lobby and sets the Nash behavior towards the other players, they chooses S * ( L, T ) to maximize its odds of election K * ( L, S , T )T/( LS ) . Similarly, the pro‐labor party chooses their policy T * ( K , S ) in the range to maximize their electoral odds L* ( K , S , T ) S/KT . The actions of each player in the political game depend on the actions of two or three of the other players, as expressed by the reaction functions K * ( L, S , T ) , L* ( K , S , T ) , S * ( L, T ) and T * ( K , S ) . Given m and n , the game has a unique interior equilibrium
( K e , Le , Se , Te ) satisfying K e = K * ( Le , S e , Te ) , Le = L* ( K e , S e , Te ) , S e = S * ( Le , Te ) , and Te = T * ( K e , S e ) . An equilibrium of the game is a set of mutually consistent actions ( K e , Le , Se , Te ) . 3. Empirical Strategy and Data In order to simulate K e , Le , S e and Te , we classified variables into three categories according to their characteristics. For the country‐specific exogenous variables, firstly, we use factor intensities of production in exportable ( ) and importable (  ) , and labor‐capital factor endowment ratio ( L0 /K 0 ) . We collect the data of the exogenous variables for each country. we selected all countries for which exports were more capital intensive than for import‐competing industries.12 First, We obtained national export, import data from World Integrated Trade Solution (WITS) from 40 countries, and select export and import‐competing industries by each country. Second, we obtained Industrial factor‐intensity data by using the World Input‐Output Database (WIOD) and Socio Economic Accounts (SEA) data that provides input data, such as labor and capital input, intermediate input, and total output data, such as total value added and total output, at the industry level including value added and total output for 35 industries in 40 countries from 1995 to 2009.Of these 35 industries, we considered only 17 manufacturing industries in our analysis. Details for the industrial classification are available Table in the Appendix. We computed the factor intensities of the all 17 industries. Factor intensities were defined in terms of the share of capital income and labor income of value added in these industries, then we select capital‐intensive industries by each country. 12
In this paper, we assume that a country exports capital‐intensive goods.
6 After selecting export industries and capital intensive industries by each country, we chose the countries where export more capital‐intensive goods than import‐competing goods. The selected countries are listed in Table 1.13 Also, we collect the labor endowment ( L0 ) and capital endowment ( K 0 ) from WIOD SEA database. We use total number of employees as the measurement for labor endowment ( L0 ) and nominal gross fixed capital formation as the measurement for capital endowment ( K 0 ) . Then calculate labor‐capital factor endowment ratio by each country. Second veriables are some of parameters, and we estimated. We estimated the industrial magnification elasticity ( m and n ) for each country. In the theoretical background presented earlier, the parameters m and n are the elasticites of the real returns to capital and labor with respect to commodity price, and they are respectively m = (1   )/(   )   and n = /(   )   . And the parameters  and  were the shares of capital income in the exportable and importable industries, respectively. Based on SEA data, we derived values for  and  for each country and then calculated m and n . 14 The values for these parameters by country are provided in Table 1.15 Lastly, we were unable to get actual data on the fractions of capital and labor lobbying for and against trade policies across countries. For this reason, we had to calculate from our model the fractions of both capital and labor that would be devoted to lobbying assuming self‐interested behavior. The optimal fractions of the factors lobbying and the trade interventions are K e , Le , S e and Te as given by the exogenous variables and other parameters. All of the exogenous variables drive the outcomes, including the magnification elasticities m and n . The capital and labor lobbies change their relative expenditures and the political parties change their vote maximizing policies. Since the exogenous production parameters and country factor endowments differ across countries, each country has a K
different optimal of capital devoted to lobbying ( e ) and and a similarly different fraction of K0
L
labor lobbying ( e ) based on the model. L0
We fit the model to actual tariff data of in the countries in this sample. We obtained the average Most Favored Nation (MFN) tariff rate for manufacture industries from 1995 to 2009. The average MFN tariff rate data for each country were obtained from World Development Indicator (WDI) from World bank database. The average MFN tariff rate by country are provided in Table 1. After assembling the data we calculated the predicted optimal lobby fraction for each 13
WIOD uses 2‐digit NACE codes, not ISIC codes. So we matched the industrial codes in the export‐import data with the factor input data using the correspondence table provided by the UN.
14
The average and for the period from 1995 to 2009 were 0.54 and 0.41, respectively. With collecting exogenous variables and we can calculate magnification elasticity and by each country.
 and  were not available by country. They ranged are from 0 to 1. Thus  and  are set at 0.5 throughout the paper as they are assumed to be identical across countries. When we change the value of  and  as 0.2, 0.4 and 0.8, it have trivial effect on the magnification elasticity m and n .
15
Here, data for the parameters in the Cob‐Douglas utility function, 7 factor for each country. We then examined whether it was consistent with the demonstrated time‐series paradox between optimal lobby and tariff rate appear with development of country. 4. Empirical Results Table 2 shows the exogenous and endogenous variables that we use in the paper. The exogenous variables are the factor intensities of production in exportable ( ) and import‐competing (  ) industry. With these exogenous variables,  and  , we calculate endogenous variables, magnification effect of capital (m ) and labor (n) . And then we K
L
calculate endogenous capital lobby equilibrium ( e ) , labor lobby equilibrium ( e ) , predicted K0
L0
tariff rate (Te ) and subsidy ( Se ) . After calculating these endogenous equilibria, we employ exogenous actual tariff rate (T ) and explore the relationship between protectionist lobbying and tariffs.16 As mentioned before, figure 1 illustrates the tariff lobbying paradox in real world. Despite increases in protectionist lobbying in the United States, actual US tariff rates declined. The figure shows US protectionist lobby spending on trade (left axis) and the average US tariff rate (right axis) over the short period of time from 2008 through 2014. The goal of this paper is to explore this potential paradox more broadly using data from 27 countries and 15 industries over the period between 1995 and 2009. To do this, we calculated the equilibrium lobby fractions for each factor by country for three different sub‐periods: 1995‐1999, 2000‐2005 and 2006‐2009. Each country’s equilibrium lobby fractions of capital and labor are provided in Table 3. We find that our estimated simulated fractions capital and labor devoted to lobbying generally increases through in the advance countries. The simple averages of the fractions of labor devoted to lobbying at the bottom of Table 3 increased from 0.265 in the first period to 0.269 in the second period to 0.282 in the third. Similar increases are shown for the fraction of capital lobbying.17 While fraction of labor lobby has increased by period, Actual tariff rates of country has decreased by 16
Except for tariff, there are a lots of non‐tariff barriers to protect in each country, which is called Non‐Tariff Barriers (NTBs). Since lack of data for these NTBs, we only use tariff rates for measurement of protection level in the paper. As well known, the measurements of NTBs are the coverage ratio or frequency index, and Nicita and Gourdon (2013) provide these dataset for multiple countries. The frequency index simply captures the percentage of products that are subject to one or more NTBs and the
coverage ratio captures the percentage of imports that are subject to one or more NTBs. We selected only the countries that are identical to those of our interest. When we estimate correlation between tariff rate and NTBs, we can see the clear positive correlation between tariffs and NTBs in all countries. The correlation is 0.8196. This means that the countries which adopt more restrictive trade policy (higher tariff rate) also imposed the non‐tariff trade barriers. In this regard, even if we used only tariff rate as the protection level because of the difficulty of obtaining the NTB data in the paper, the result is not a significant problem. 17
We did a separate test (not shown) comparing advanced countries to developing countries by dividing countries into OECD and non‐OECD countries. The average capital lobbying ratio for OECD countries in the 1st period was 0.101, but increased to 0.108 in the 3rd period. In contrast, the average capital lobby fraction for non‐OECD countries is 0.09 in the 1st period, decreasing slightly to 0.08 in the 3rd period.
8 period. The actual tariff rate for all countries is 6.13 in the 1st period, 4.84 in the 2nd period, and 4.15 in the 3rd period. Figure 2 shows the tariff lobbying paradox in the simulated general equilibrium from our model. Actual tariff rates in the data decline with the simulated general equilibrium fraction of labor engaged in protectionist lobbying. There is inverse relationship between equilibrium lobby fraction and actual tariff rates. How are intuition tells us that tariffs will increase more the greater the protectionist lobbying effort? This is only valid in partial equilibrium reasoning from Grossman and Helpman. They only consider interactions between the government and organized lobby as the endogenous while equilibrium cross‐industry pattern of tariff protection is given. However in the Magee Brock and Young model of endogenous protection, lobbying and tariffs are both endogenous, which removes the necessary positive correlation between the two in general equilibrium. The data and simulations using our model show that there is no necessary positive correlation between protectionist lobbying and tariffs. We now set about to report the exogenous forces that drive both tariffs and lobbying. We find that there are two basic drivers that break the positive relationship between tariff lobbying and tariff rates. The change of two major factors in our endogenous tariff model, country capital‐labor ratios, K 0 /L0 , and the magnification elasticity, n , might explain this paradox. The first economic driver of the paradox between tariff rates and lobbying is capital‐labor endowments ratio, K 0 /L0 , effect. This endowment effect is the direct effect of country capital‐labor endowment ratios on tariffs. There is a battle politically in each country between capital and labor over external policy. Labor is clearly prefers restrictions on imports since tariff increases wage rates. Capital, on the other hand, is internationally mobile and wants free trade and open markets both at home and abroad. Figure 3 shows the endowment effect on tariff. The higher the capital‐labor ratio in a country, the lower is the tariff rate since labor as the scarce factor relative to capital. This is one potential explanation for the negative relationship between tariffs and lobbying as countries develop. Tariffs fall as capital deepening occurs for developed countries. The process of economic development is one of capital accumulation so that the resulting rise in country capital to labor ratios causes tariffs to fall and export subsidies to rise as Magee Brock and Young showed that countries with small amounts of capital relative to labor would have higher tariff rates because of greater influence of labor in the political system. Also, the labor became relatively scare than capital as capital‐labor endowments ratio, K 0 /L0 , rises voice power of labor is dominated by capital. In order to overcome quantitative problem, the labor interest group start increasing their lobbying. Figure 4 explores the effect of capital‐labor endowments ratio on labor lobbying. The higher capital‐labor endowment ratio in a country, the higher is the fraction of labor devoted to protectionist lobbying. Figure 3 and Figure 4 explain the paradox by showing that capital‐labor endowments ratio increase tariff rate decrease while labor lobbying increase. Second economic driver of paradox is the factor price magnification effects. A factor price magnification elasticity is the percentage change in the factor price (either rentals or wage rates) with respect to changes in product prices. Figure 5 shows that as countries develop, the wage magnification effect n also slightly increase. As 9 wage magnification effect increase labor interest group react more subtly to price of product. Therefore, the higher the wage magnification effects the higher would be the fraction of laborer devoted to protectionist lobbying. However, in this case, as wage magnification effect increase tariff rate of country also increase. Figure 6 shows that there is weak positive relationship between tariff rate and wage magnification effect. This effect run against paradox, which is negative relationship between lobby and tariff rate. How, then, do magnification elasticities for wages relate to the capital‐labor endowment ratios of countries? This is because rent magnification effect, m , increases as economic growth. As rent magnification effect rises, the capital lobbying increases since capitalists also become more senstive than before. Moreover, as countries develop capital becomes more abundant relaitve to labor, labor lobbying could offset the capital lobbying. Figure 7 shows that there is an extremely strong positive relationship between the economic development process of rising capital – labor ratios and the magnification elasticity of rental rates with respect to product prices. The following equations (7) and (8) partially confirm this effect. These equations are 3‐period panel regressions, where the dependent variable is the tariff rate, while the exogenous variables are the capital‐labor endowment ratio ( K 0 /L0 ) and wage and rent magnification elasticities (n, m). 1
tariff
β
1
tariff
β
7 8 The first and second columns of Table 4 are the regression results of equation (7) and (8) respectively. The coefficents of capital‐labor endowments in both columns are negative and statistically significant. This result reflects the endowment effect necause the higher the capital‐labor ratio in a country, the lower is the tariff rate as labor is the scarce factor relative to capital. The interesting thing is that the coefficent of n is positive and significant at 10% level. This reflect that when wage magnification effect increases, tariff rates rise because laborer becomes more sensitive to product prices. However, an offset is that the coefficient m is negative. Thus even though labor devoted to protectionist lobbying increase by increasing in wage magnification effect, this appears to be more than offset by an increasing capital rental rate magnification effect. Note in figure 7 the significant increase in the capital magnification elasticities as country capital – labor ratios rise. HThus, labor lobbying effects appear to the weaker than those of capital.. The bottom line is that this is a second result explain why Otariff rates fall despite increased labor lobbying. 5. Summary and Conclusion 10 The empirical results in this paper are based on the endogenous tariff model of Young and Magee (1986) with two goods, two factors, two lobbies and two political parties. We used capital and labor income share data to measure factor intensities of production from the World Input Output Database SEA from 1995 to 2009. We then observedhouse simulated optimal lobby spending by both capital and labor and actual country Most Favored Nation tariff rates. We had to use simulated lobby values from theof Young and Magee (1986) model because we did not have actual lobbying data. Since both lobbying and tariffs are endogenous, there is no necessary relationship between the two. However, we generally observe negative correlations between predicted protectionist lobbying and tariffs, whichis also observed in the real world. This results is constrast with existing literacture on lobbying and protection. The existing literature suggests that protection increases as lobbying from import competing industries rises.
There are two reasons for the paradox that tariff rates fall across countries despite increased protectionist lobbying. First, country capital to labor endowment ratios rise with economic development. Labor becomes less and less important relative to capital in higher income countries, both in the economy and politics. Thus tariffs, which protect labor, decline with economic development.18 Second we examine forces related to increased protectionist lobbying. Capital deepening in the last two decades has caused a convergence of capital‐labor ratios between export and import‐competing industries. This implies greater similarity in factor intensities of production between export and import‐competing industries. This result causes an increased elasticity of factor prices with respect to product prices, the well‐known magnification effect from international trade.. Thus, even smaller tariffs can cause larger redistributive effects in favor of the protectionist factor, labor. We observe an increasing fraction of labor devoted to protectionist lobbying as countries develop. This is true in the United States in figure 1 and it is true in our cross section of 27 countries. Also as wage magnification effect increase with economic develop, fraction of labor devoted to protectionist lobbying increases because labor interests group becomes more sensitively to tariff rate. Third, there is forces with contrary effects on tariffs. The capital – labor endowment effect lowers tariff through time while increased lobbying effects by labor increase tariffs through time. We find that there is a weak positive association between actual tariffs and wage magnification effects (figure 6). This might be linked to the weak positive association between country factor endowments K 0 /L0 and wage magnification effects (figure 5). While there is a weak positive association between tariffs and wage magnification effects, there is strong positive relationship between country capital‐labor endowments and rent magnification effects. As a result, capital lobbying becomes increasingly effective relative to labor lobbying through time. This latter effect from capital magnification apparently reinforces the capital – labor ratio effect so the net result is declining tariffs. . 18
This is the endowment effect from Magee, Brock and Young whereby the dominant factor in an economy obtains more favorable treatment in politics.
11 Thus, the tariff‐lobbying paradox is explained. References
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14 Figure 1: Comparison between lobby spending on trade and tariff rate unit ($1,000,%) Source: Federal Election Commission and WITS
Figure 2: Tariff rate fall as the simulated fraction of labor lobbying rises
Note. R‐squared in a regrssion of tariff on Le/Lo equals 0.217 which is statically significant level at 1%. Excluding the developing nations (Indonesia, Brazil, Mexico) the R‐squared is 0.5817 which is statically significant level at a higher level. 15 Figure 3: The negative country capital‐labor endowment effect on tariff rates
Note. R‐squared : 0.1434 and p‐value : 0.068 (significant level at 5%) Figure 4: Simulated protectionist labor lobbying increases with capital‐labor endowment ratio
Note. R‐squared : 0.0737 and p‐value : 0.134 16 Figure 5: Wage magnificationrelated to capital‐labor endowments
Note. R‐squared : 0.029 and p‐value : 0.511 Figure 6: Actual tariff rate on wage magnification elasticities
Note. R‐squared : 0.1419 and p‐value : 0.070 (significant level at 5%) 17 Figure 7: Capital rental rate magnification increases with capital‐labor endowments
Note. R‐squared : 0.8081 and p‐value : 0.00 (significant level at 1%) 18 19 Table 1: Key parameters (1995‐2009 average) Source: World bank and Author’s calculation 20 Table 2
Exogenous and endogenous variables used in the model
A. Exogeneous Variables


Lo/Ko
T
Factor intensity of production in exportable Factor intensity of production in importable Labor‐capital country factor endowment ratio Actual MFN tariff rates B. Endogenous Variables
m
Elasticities of the real returns to capital n
Elasticities of the real returns to labor Ke/Ko
Optimal lobby fraction of capital Le/Lo
Optimal lobby fraction of labor Predicted (1+s) export subsidies Predicted tariffs (1+t) Se
Te
21 Table 3: Predicted fractions of factors lobbying K e /K 0 , Le /L0 by country Source: World bank and Author’s calculation
22 Table 4: Magnification effects Dependent variable : Ln (1+tariff rates)
Ln (Ko/Lo) Ln (n) (1)
(2)
‐0.070** (0.029) 0.028* (0.015) ‐0.061* (0.034) Ln (m) Constant Dummy 1 Dummy 2 N R‐square ‐0.032* (0.017) 2.383*** (0.542) ‐0.016** (0.005) ‐0.021*** (0.006) 78 0.09 2.171*** (0.379) ‐0.016*** (0.006) ‐0.021*** (0.006) 78 0.13 notes: (1) panel polled OLS (2) Standard errors in parenthesis (3) *, **, *** indicate statistical significance at 1%, 5% and 10% level 23 Appendix 1: WIOD Industry Codes
Source: World Input‐output database 24