Grossman Helpman 1995

Grossman & Helpman 1995 Trade Wars and Trade Talks Two level game: (1) strategic interaction between domestic interest groups and their government; (2) strategic interaction between domestic and foreign governments. Contribution: Incorporates domestic political concerns into governments’ international trade negotiations by modeling governments’ utility as a weighted sum of (a) providing high standard of living for constituents and (b) collecting campaign contributions from interest groups. 4 PLAYER TYPES  Domestic and foreign interest groups (many, each represents an industry i)  Domestic and foreign government ENDOGENOUS CHOICES  Interest groups choose contribution schedules simultaneously  Governments choose tariff/subsidy schedule — either via negotiation or unilaterally  Note: Higher import tariff on good i (τi) has 4 effects on utility/welfare:  domestic industry i;  domestic consumers of good i;  foreign industry i;  foreign consumers of good i;  TRADE WAR: contribution schedule depends only on home government’s actions; governments behave unilaterally by ignoring the impacts of their actions on political and economic agents of the other country.  TRADE TALKS: contribution schedule depends on both government’s actions NOTATION  i : industry index. Each industry i produces good i and is represented by interest group i  ci : contribution schedule if interest group i C : total contributions received by domestic politicians  wi : welfare function of interest group i W : aggregate domestic consumer welfare  1 + τ : home government tariff/subsidy rate schedule (τ* is foreign government’s) o τ > 1 is import tariff (export subsidy); τ < 1 is import subsidy (export tariff) o τ is schedule of tariffs comprised of all τi on goods from all industries iI  * denotes foreign º denotes equilibrium i : world price of good i ASSUMPTIONS  Interest groups choose contribution schedules simultaneously  Domestic interest group contribution schedules are not known by foreign government  z = good produced solely by labor PREFERENCES (UTILITY FUNCTIONS) 1. Trade War (governments choose τ independently)  Interest group i: Wi(τ,) – Ci(τ,·) {Welfare – Contributions}  Government: i Ci(τ,·) + a W(τ,) ; a ≥ 0 {Total contributions + weighted welfare} 2. Trade Talks (governments choose τ cooperatively)  Interest group i: Wi(τ,) – Ci(τ,·)  Home govt: i Ci(τ,τ*) + a [W(τ,τ*) + R] ; a ≥ 0  Foreign govt: i Ci*(τ*,τ) + a [W(τ*,τ) - R] ; a ≥ 0 {note minus R} PAYOFFS  Government = i ci(τ,τ*) + a W(τ,τ*)  {interest groups contributions}+{weight govt places on welfare, relative to contributions}{social welfare} Interest group i = wi(τ,τ*) – ci(τ,τ*) {its welfare}- (its campaign contribution} SOLUTION CONCEPT  Nash equilibrium: no party benefits by deviating from equilibrium 1. ACTIONS IN TRADE WAR Government: in response to τ*, chooses τº = arg maxτ  Ciº(τ,τ*) + a W(τ,τ*) {condition a} s.t. every interest group i maximizes wi(τ,τ*) – ci(τ,τ*)  Equilibrium trade policy τº maximizes joint welfare of government and each industry group i when contribution schedules of all other interest groups (jI ji) are taken as given  Assumes: o interest groups do not cooperate o interest groups choose contribution schedules based on expected policies of both home and foreign government’s (though they cannot influence foreign government’s policy) o interest group contributions cannot be observed abroad.  Solution satisfies condition a and τº = arg maxτ W(τ,τ*) - Ciº(τ,τ*) + jL Cjº(τ,τ*) + a W(τ,τ*) for every iL Implications  Governments are willing to impose deadweight loss on their constituencies to increase campaign contributions.  Because government choose policies independently of each other, they impose avoidable political costs on each other (this provides the motive for trade talks) Comparative statics (p. 693)  In non-cooperative game, when the government’s reduces its weight on consumer welfare (a) it will be more responsive to domestic industry lobbying (for protectionism, so government raises domestic tariffs) which increases prices of home import goods (e.g., Bush & US steel import tariffs). Paradox (p. 694)  Government that is unresponsive to the public interest (smaller ―a‖) might actually serve the general voter well, because the self-interested government can credibly commit to a policy of aggressive support for the domestic industry. (p. 694) 2. ACTIONS IN TRADE TALKS  Motivated to avoid political costs imposed by lack of coordination by governments in trade war mode, governments now seek to choose policies cooperatively via ―trade talks‖  Governments negotiate over both schedules τ and τ* (and may create a transfer payment R) to maximize joint welfare of politicians  Solution: Governments together choose (τº,τ*º) = arg maxτ,τ* i Ciº(τ,τ*) + a i Ci*º(τ*,τ) + a*a [W(τ,τ*) + W*(τ*,τ)] s.t. each interest group i maximizes wi(τ,τ*) – ci(τ,τ*) given every other interest group’s contribution schedule {no interest group can gain by via another schedule}  Nash solution only gets to ratio of τ/τ* ; uses Rubenstein bargaining model to resolve levels Implications (p. 701) In Trade Talks game, domestic industry group i is more successful when: 1. It has greater stake in the negotiations than same industry group abroad 2. Its domestic government places less weight on average welfare (a