Factor Endowments, Democracy, and Trade Policy Divergence

• DOI: http://doi.org/10.1111/jpet.12057
• Date: 01 February 2014
• Published date: 01 February 2014

FACTOR ENDOWMENTS,DEMOCRACY,AND TRADE POLICY

DIVERGENCE

SEBASTIAN GALIANI

Washington University in St. Louis

NORMAN SCHOFIELD

Washington University in St. Louis

GUSTAVO TORRENS

Washington University in St. Louis

Abstract

We develop a stochastic model of electoral competition in

order to study the economic and political determinants of

trade policy. We model a small open economy with two

tradable goods, each of which is produced using a sector-

specific factor (e.g., land and capital) and another factor

that is mobile between these tradable sectors (labor); one

nontradable good, which is also produced using a specific

factor (skilled labor), and an elected government with the

mandate to tax trade flows. The tax revenue is used to pro-

vide local public goods that increase the economic agents’

utility. We use this general equilibrium model to explic-

itly derive the ideal policies of the different socioeconomic

Sebastian Galiani, Department of Economics, Washington University in St. Louis, Campus

Box 1208, One Brookings Drive, St. Louis, MO 63130-4899, USA (galiani@wustl.edu). Nor-

man Schofield, Department of Political Science, Washington University in St. Louis, Cam-

pus Box 1207, One Brookings Drive, St. Louis, MO 63130-4899, USA (schofield.norman@

gmail.com). Gustavo Torrens, Department of Economics, Washington University in St.

Louis, Campus Box 1208, One Brookings Drive, St. Louis, MO 63130-4899, USA (gftor-

rens@go.wustl.edu).

We appreciate very helpful comments from two anonymous referees, Daniel Heymann,

David Levine, Paulo Somaini, Donald Saari, and participants at World Congress of the

Econometric Society 2010, the International Conference on Political Economy and Insti-

tutions 2010, APET Meeting 2010, Annual Meeting of DEGIT 2010, and Annual Meeting

of LACEA 2010, the Meeting of SAET, 2011, and seminar participants at World Bank,

Washington University in St. Louis, and Universidad de San Andr´

es. Norman Schofield

acknowledges financial support from NSF grant 0715929 and Sebastian Galiani acknowl-

edges financial support from ESRC grant 062-23-1360.

Received November 17, 2010; Accepted January 18, 2012.

C2013 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 16 (1), 2014, pp. 119–156.

119

120 Journal of Public Economic Theory

groups in society (landlords, industrialists, labor, and skilled

workers). We then use those ideal policies to model the indi-

vidual probabilistic voting behavior of the members of each

of these socioeconomic groups. We use this model to shed

light on how differences in the comparative advantages of

countries explain trade policy divergence between countries

as well as trade policy instability within countries. We regard

trade policy instability to mean that, in equilibrium, polit-

ical parties diverge in terms of the political platforms they

adopt. We show that in natural resource (land)–abundant

economies with very little capital, or in economies that spe-

cializes in the production of manufactures, parties tend to

converge to the same policy platform, and trade policy is

likely to be stable and relatively close to free trade. In con-

trast, in a natural resource–abundant economy with an im-

portant domestic industry that competes with the imports,

parties tend to diverge, and trade policy is likely to be more

protectionist and unstable.

1. Introduction

Many developing countries adopted trade protectionist measures during the

second part of the 20th century. Most of these countries, if not all of them,

did not have a comparative advantage in the manufacturing sector and they

did not industrialize in a sustainable way as a result. Instead, they had a

comparative advantage within the primary sector. In contrast, countries with

comparative advantage in the manufacturing sector tended to remain much

more open to trade. In addition, the countries that adopted import substitu-

tion policies tended to show substantial volatility over time in their trade poli-

cies. In this paper, we develop a stochastic model of electoral competition to

study the economic and political determinants of trade policy. Our goal is to

provide an explanation of the variability of trade policy both across countries

and within a country over time, rather than across industrial sectors.

Many models of political choice emphasize political convergence to an

electoral mean or median. Although extremely useful to study important

questions in the field of political economy, such models appear to be of lim-

ited use in explaining the oscillations that can occur as a result of divergent

political choices by parties. Schofield (2007) suggests, however, that politi-

cal parties will not converge if there is sufficient difference in the valences of

political leaders, where the valence of a candidate captures all the character-

istics of the candidate and the party that affect voting decisions and are not

related with policy platforms. Furthermore, in this version of the stochastic

model, there is convergence or divergence depending on pure political fac-

tors, such as the difference in the valances of the candidates, as well as on

the distribution of voters’ policy preferences, which ultimately depends on

structural characteristics of the economy.

Factor Endowments, Democracy, and Trade Policy Divergence 121

We model a small open economy with two tradable goods, each of which

is produced using a sector-specific factor (land and capital) and a third fac-

tor (e.g., labor) which is mobile between these tradable sectors. There is also

one nontradable good, which is produced using a specific factor (skilled la-

bor). The political model has an elected government with the mandate to fix

an ad valorem import tax rate. The tax revenue is used to provide two local

public goods. One public good is targeted at the specific factors of produc-

tion whereas the other is targeted at the mobile factor of production. We

use this general equilibrium model to derive the ideal policies of the differ-

ent socioeconomic groups in society (landlords, industrialists, workers, and

service workers). We then use those derived ideal policies to model the indi-

vidual probabilistic voting behavior of the members of each of these socioe-

conomic groups. The combined model is thus based on micropolitical econ-

omy foundations of citizens’ preferences. We believe this paper is the first

to employ this methodology in order to study how differences in the factor

endowments of countries explain trade policy divergence between countries

as well as trade policy instability within countries.

Just as in Grossman and Helpman (1994,1996), we consider two inter-

connected sources of political influence: electoral competition and interest

groups. In their study of the political economy of protection, Grossman and

Helpman proposed a model of protection in which economic interests orga-

nize along sectoral lines, so that interest groups form to represent industries.

Their model predicts a cross-sectional structure of protection, depending on

political and economic characteristics, and provides an excellent model of

within country cross-section variability of trade policy. In contrast, we focus

on the variability of trade policy both across countries and within a country

over time, rather than across sectors.

Our work is related to the analysis of Rogowski (1987,1989) on the ef-

fects of international trade on political alignments (see also Baldwin 1989).

Rogowski (1987) elaborates a lucid explanation of political cleavages, as

well as changes in those cleavages over time as a consequence of exoge-

nous shocks in the risk and cost of foreign trade. Rogowski (1987) classifies

economies according to their factor endowments of capital, land, and labor,

and uses his classification to deduce two main types of political cleavages:

a class cleavage and an urban–rural cleavage. The model that we present

includes nontradable goods and this allows for a richer characterization

of political alignments. In particular, in natural resource (land)–abundant

economies, without the inclusion of nontradable goods, landlords favor free

trade, and industrialists and workers are protectionist, inducing an urban–

rural cleavage. However, once nontradable goods are introduced in the

model, distributive conflict among urban groups will also be present. Indus-

trialists and unskilled workers may favor protectionist policies while skilled

workers favor free trade policies (see Galiani, Heymann, and Magud 2009).

Furthermore, we show that the presence of a distributive conflict between