LESSON

6: POLITICAL ECONOMY OF TRADE: SOCIETY-CENTERED APPROACH

What are the interests of trade when governments are negotiating at WTO or RTAs? What
determines the specific trade objectives by governments? As Oatley states, government’s trade
policy objectives are shaped by politician’s responses to interest groups’ demands. For example,
the EU is reluctant to liberalize agriculture in respond to demands of farm interests, while the
Japanese government maintains high tariffs on imported rice.

The society-centered approach emphasizes the interplay between organized interests and
political institutions. Since trade has distributional consequences (for example, a decaying textile
sector in the USA), it is shaped by the government’s responses to the demands of different
interest groups, liberalizing and protectionist groups. These government responses are shaped by
political institutions. There are several models that try to explain this.

MODELS

FACTOR MODEL AND CLASS CONFLICT

This model states that the competition of factors (labour and capital) are what shape trade
policies. There is a conflict between workers and owners of capital as they are in direct
competition over the distribution of national income.

The model assumes there are two countries, two goods and two factors of production. For
example, shirt production relies heavily on labour and less in capital, while computer production
more in capital and less in labour (these two industries are examples of industries with different
endowments). The US is endowed with a lot of capital and China with a lot of labour. Then, the US
will produce and export the capital-intensive good (computers) and it will import the labour-
intensive good (shirts), opposite to China. This happens because countries have a comparative
advantage in producing goods that require their relatively abundant factor.

In the USA, there are two main consequences from trade. First, as the demand for shirts
from the USA fall, the apparel firms liquidate their capital and lay off their employees. Secondly,
computer firms from the USA are expanding production, and so they demand more capital and
labour and they begin employing the capital and labour that were previously in the shirt industry.
However, there is an imbalance between the factors being released and those being demanded.
Since the US is releasing a lot of labour and little capital (from the production of shirts that has
stopped) but to produce computers you need more capital than labour, the price of capital rises
and wages fall.

 In the absence of trade in the capital abundant country, the USA, returns from capital are
low. Labour is relatively scarce, so wages are high. By opening up to trade, the return of capital will
rise until it equals the dropping rate in trading partner countries. Also, wages will drop until they
equal the rising wage in trading partner countries.

In the absence of trade in the labour abundant country, China, capital is relatively scarce,
so rents are high. Labour is cheap, so wages are low. By opening up to trade, capital rents will fall
until they equal the rising rate of return in trading partners, and wages will rise until they equal
the falling wage in trading partner countries.

According to Stopler-Samuelson’s theorem, if trade continues steady, at some point in

time prices of factors will equalize. There is some evidence that supports this theory, but we need
to also be aware of its critiques: labour and capital are not homogeneous, and they cannot just
move around across sectors.

HOW DOES THIS AFFECT TRADE POLICY?

Because trade causes the scarce factor’s income to fall, scarce factors will want to
minimize trade. As abundant factor’s income is to rise, they prefer low tariffs to capture gains
from trade. Therefore, some groups want to liberalize and others want to protect.

Trade politics are thus driven by conflict between labour and business (or capital) and is
often called a class-based model of trade politics.

SECTOR MODEL

According to this model, trade politics are driven by competition between industries.
Trade faces the workers and capitalists employed in one industry against the workers and
capitalist employed in another industry in the conflict over the distribution of national income.

Trade divides society across industry rather than factor lines. The assumptions this model
makes about factor mobility (the ease with which labour and capital can move from one industry
to another) are different from the ones made in the factor model. On the factor model, there was
high mobility. However, this model states that factors are not easily moved from one industry to
another. Instead, factors are tied, or specific to the sector in which they are currently employed
(nor capital neither labour are mobile). There are specific skills to sectors (what is a textile worker
going to do in a computer factory; and how is a sewing machine supposed to help in computer
production), logistic problems (geographical differences and moving) and attachments to
communities that don’t allow factor movement. Then, both labour and capital gain or lose from
trade. The result of this is not a class conflict but conflict between industries.

Then, the labour and capital employed that rely intensively on society’s abundant factor
gain from trade (capital intensive and high technology in advanced industrialized countries): the
export oriented sector. However, the labour and capital employed in industries that rely
intensively on society’s scarce factor (textile industries and similar in industrialized countries) lose
from trade: the import-competing sector.

Therefore, debate in
globalization is between the
factor model (labour versus
capital) and the sector model
(capital and labour in import
competing vs capital and
labour in export oriented
industries).

However, recent studies challenge both models. They suggest that people base their
preferences on trade policy on perceptions of what’s best for the country as a whole through
attitudes to foreigners or related to how trade is going to affect the national economy rather than
in specific sectors. This also explains why preferences change over time: a person may support
trade during economic booms and opposite it during recessions.

THE COLLECTIVE ACTION PROBLEM

The collective action problem also influences how groups affect trade policies. We know
that individual preferences must be organized in order to exert influence on the policy-making
process, or else there is no way for them to lobby. This could be difficult and people could just not
organize at all.

The collective action problem explains why. Consumers would gain from free trade, but
lobbying is very costly. Since consumers are a big group, if one person doesn’t do it, the whole
process isn’t harm. The issue is that if everyone thinks that, no one does anything. Individuals ride
free and collective action doesn’t happen. However, producers are a more homogeneous and
better organized group. They are a small group that concentrates a lot of benefits, so they don’t
ride free. This situation helps us understand:

1. Why producers rather than consumers dominate the market. 


2. Why trade politics have a tendency towards protectionism (agriculture). 


3. Why governments rarely liberalize trade unilaterally. They only do so in reciprocal trade

agreements, when an industry that benefits from liberalization wants the agreement and
lobbies itself. 


Thus, competition takes place between organized interest groups that are sometimes class
groups or industry-specific groups.

POLITICAL INSTITUTIONS & THE SUPPLY OF TRADE POLICY

There is general agreement that political institutions play an important role transforming
interest group demands in trade policies. However, there is less agreement about how exactly
they do so.

Of course, political institutions place rules which shape the strategies people adopt in
pursuit of their policy objectives. They detail how interest groups are organized and whether these
interest groups lobby the legislature or exert influence through political parties. They provide the
mechanism to aggregate preferences in society. Finally, when they rule, they decide which
interests gain representation and which don’t.

ELECTORAL SYSTEM

The electoral system is an institution that all scholars agree has an important impact on
trade politics. It is classified into two categories:

1. Majoritarian: the one who obtains the biggest quantity of votes is elected (a single
member, first-past-the-post election). 


2. Proportional: multi-member districts to distribute legislative representation in proportion

to the share of the popular vote each party attracts. 


There are different theories about how electoral systems affect trade:

§ In majoritarian systems, with small districts that have very specific interests, industry
lobbies tend to predominate (auto industry in Detroit). In proportional systems, where
parties need to reach bigger populations, groups of interests are factors/clases
(Norwegian Labour party strongly tied to labour unions).

The level of protection adopted by governments in the two systems differ. Smaller groups
that benefit from protection can easily influence policy in majoritarian systems. This, for the
reasons stated above, doesn’t happen a lot proportional systems.

Nevertheless, evidence about which institutional features deliver insulation effectively and
whether it translated into lower levels of protection remains somewhat inconclusive. There is in
fact some evidence that proportional systems are more protectionist than majoritarian systems.

VETO PLAYERS

A veto player is a political actor whose agreement is necessary in order to enact policy.
Thus, veto players influence trade policies. Systems can have one veto player (from example,
previously the ruling party in Great Britain) or many veto players (multi-party governments). In
trade politics, systems with many veto players will find difficulty to alter tariffs in response to
social pressure for change. Research has shown some evidence for this.