A State-Centered Approach to the Politics of Trade

READING ASSIGNMENT: Oatley – Chapter 5

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Plan

• What does the state want?

– Survival

• Why would the state intervene?

– Infant Industries

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What does the state want?

• Improve overall welfare

• Increase its relative power

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What does the state want?

• SURVIVAL!

• Political Institutions shape the incentives of political leaders

• Under democracy, leaders survive by winning votes

• Under dictatorship, leaders survive by satisfying elite constituents: – military, big business, foreign interests

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Democracy vs. Dictatorship

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Hazard Rate over Time for Democracies (Solid Line) & Dictatorships (Dotted Line) – Time in years

2015105

0.625

0.5

0.375

0.25

Time (years)

Hazard Rate

Time (years)

Hazard Rate

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Time in office

• Does *not* improve a democratic leader’s chances in office

• What then helps democratic leaders survive?

• PROVISION OF “PUBLIC GOODS”

• In the United States:– Economic Growth

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Time in office

• *Does* improve an autocratic leader’s chances in office

• Why?

• PROVISION OF “PRIVATE GOODS”

• Pay off a small, loyal group of supporters– Military elites

– Business elites9

Changing focus toA more specific institution: Legislative Representation

• Proportional?

• Or Malapportioned?

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Who needs the most gasoline per capita?Urban v Rural

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Policy outcome?

• We’ve got Interests & Incentives

• Now, to get the policy outcome,…

• We interact interests/incentives with a domestic political institution:

Malapportionment!

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Malapportionment tends to weigh RURAL preferences more than URBAN

(i.e., Proportional representation tends to weigh URBAN preferences more than RURAL)

Does this have an effect on NATIONAL policy?

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Test:

• Does malapportionment affect:

–Gasoline prices

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How can the state get what it wants?

• Industrial Policy

• Tariffs

• Subsidies

• Investment

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Why does the state protect?

• One answer: Infant industries

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Infant-industry case

• Long-run welfare gains created by a new industry will be greater than the short-run losses of social welfare

• “infant” industries – like children who need the “protection” of their parents until they grow strong

• Comparative advantages are DYNAMIC

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• Both states are better off with trade…BUT• Would you rather live in Brazil with trade?• Or the United States with autarky?

Infant Industry Argument 1:Fixed costs & Economies of scale

• Economies of scale refers to the decreased per-unit-cost as output increases.

• The initial investment of capital is diffused (spread) over an increasing number of units of output

The marginal cost of producing a good or service decreases as production increases

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Example

• Suppose an industry requires an initial investment (fixed cost) of $1000

• With 100 customers, the Average Fixed Cost is $10

• With 200 customers, the Average Fixed Cost becomes $5

• This results in a lower average total cost

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• No economies of scale:– If costs increase proportionately to the quantity of all

input factors

• Diseconomies of scale:– If costs increase by a greater amount than the

quantity of all input factors

• Economies of scale:– If costs decrease by a greater amount than the

quantity of all input factors

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A different way to approach “returns to scale”

• Where all inputs increase by a factor of 2, new values for output should be:

– Twice the previous output = ?

• a constant return to scale

– More than twice the previous output = ?

• an increased return to scale

– Less than twice the previous output = ?

• a decreased return to scale23

Formal notation• Y is output, K is capital, L is labor, F is the production function:

Y=F(K,L)

• Suppose we double our inputs:

2K, 2L

• F(2K,2L) = ???

–How much does Y increase?

• If F(2K,2L) = 2F(K,L) We have _______ returns to scale

–CONSTANT

• F(2K,2L) > 2F(K,L) We have _______ returns to scale

–INCREASING

• If F(2K,2L) < 2F(K,L) We have _______ returns to scale

–DECREASING 24

Slightly more abstract notation

• Y is output, K is capital, L is labor, F is the production function, a is the increase in inputs

• Y=F(K,L)

• If F(aK,aL)=aF(K,L) Constant returns to scale

• If F(aK,aL)>aF(K,L) Increasing returns to scale

• F(aK,aL)<aF(K,L) Decreasing returns to scale

• For fun: Apply this to the “Cobb-Douglas” production function! Yippee!

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Bringing the two sets of concepts together?

• Y=F(K,L) + start up costs

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You can have increasing returns to scale if…

Start-up costs are high

And/or if investments in inputs generate disproportionately high increases in outputs

Infant Industry Argument 2:Economies of experience

• Efficient production requires specific skills that can only be acquired through production in the industry

– Experienced management

– Skilled workers

– Network of suppliers

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Why can’t markets efficiently educate / train the workforce?

• Trained people may leave the firm, taking their skills elsewhere

• Missing market:– “Futures market for labor”

• Externalities from education?

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Economies of scale &/or experience can lead to:

• Oligopoly, market power

• Barriers to entry

• First mover advantages

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Suppose an industry where market-demand supports only one firm (high tech – e.g., aircraft)

PRODUCE NOT PRODUCE

PRODUCE – 5, – 5 100, 0

NOT PRODUCE

0, 100 0, 0

European firm

What are the two EQUILIBRIA? (R,C)

US firm

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Equilibrium:

• An outcome where no player has an incentive to deviate from his or her chosen strategy given the strategies of the other players.

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Whoever moves first wins!

• http://www.youtube.com/watch?v=K4GAQtGtd_0&feature=related

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Now suppose the US moved first, but Europe offers a subsidy… (R,C)

PRODUCE NOT PRODUCE

PRODUCE – 5, 5 100, 0

NOT PRODUCE

0, 110 0, 0

European firm

US firm

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Take-aways

• What do governments want? Survival• Democracy v. Autocracy• Malapportionment• Why does the state intervene?• Infant Industries• Economies of Scale• Increasing returns to scale• Economies of experience• First mover advantages• Equilibria

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Thank youWE ARE GLOBAL GEORGETOWN!

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