International Trade Theory and Policy
by Steven M. Suranovic

Trade 120-5D

Political Economy Issues: The Problem with Democratic Processes

In democratic societies government representatives and officials are meant to carry out the wishes of the general public. As a result, decisions by the government are influenced by the people they represent. Indeed, one of the reasons "free speech" is so important in democratic societies is to assure that individuals can make their attitudes towards government policies known without fear of reproach. Individuals must be free to inform the government of which policies they approve and of which they disapprove if the government is truly a representative of the people. The process by which individuals inform the government of their preferred policies is generally known as lobbying.

In a sense, one could argue that lobbying can help to eliminate some of the informational deficiencies faced by governments. After all, much of the information the government needs to make optimal policies is likely to be better known by their constituent firms and consumers. Lobbying offers a process through which information can be passed from those directly involved in production and consumption activities to the officials who determine policies. However, this process may turn out to be more of a problem than a solution.

One of the results of trade theory is that the implementation of trade policies will likely have an effect on income distribution. In other words, all trade policies will generate income benefits to some groups of individuals and income losses to other groups. Another outcome, though, was that the benefits of protection would likely be concentrated, that is, the benefits would accrue to a relatively small group. The losses from protection, however, would likely be dispersed among a large group of individuals.

This outcome was seen clearly in the partial equilibrium analysis of a tariff. When a tariff is implemented, the beneficiaries would be the import competing firms who would face less competition for their product and the government who collects tariff revenue. The losses would accrue to the thousands or millions of consumers of the product in the domestic economy.

As an example consider a tariff on textile imports being considered by the government of a small perfectly competitive economy. Theory shows that the sum of the benefits to the government and the firms will be exceeded by the losses to consumers. In other words national welfare would fall. Suppose the beneficiaries of protection are 100 domestic textile firms who would each earn an additional $1 million in profit as a result of the tariff. Suppose the government would earn $50 million in additional tariff revenue. Thus, the total benefits from the tariff would be $150 million. Suppose consumers, as a group, would lose $200 million implying a net loss to the economy of $50 million. However, suppose there are 100 million consumers of the products. That implies that each individual consumer would lose only $2.

Now if the government bases its decision for protection on input from its constituents then it is very likely that protection will be granted even though it is not in the nation's best interest. The reason is that textile firms would have an enormous incentive to lobby government officials in support of the policy. If each firm expects an extra $1 million, it would make sense to hire a lobbying firm to help make your case before the government. The arguments to be used, of course, are 1) the industry will decline and be forced to lay off workers without protection, thus protection will create jobs, 2) the government will earn additional revenues that can be used for important social programs, and 3) the tax is on foreigners and is unlikely to affect domestic consumers (#3 isn't correct, of course, but the argument is often used anyway). [Click here to see why.] Consumers, on the other hand, have very little individual incentive to oppose the tariff. Even writing a letter to your representative is unlikely to be worth the $2 potential gain. Plus the consumer would probably hear (if they hear anything at all) that the policy will create some jobs and may not affect the domestic price much anyway (after all the tax is on foreigners).

The implication of this problem is that lobbying process may not accurately relate to the government the relative costs and benefits that will arise due to the implementation of a trade policy. As a result the government would likely implement policies that are in the special interests of those groups who stand to accrue the concentrated benefits from protection, even though the policy may generate net losses to the economy as a whole. Thus by maintaining a policy of free trade, an economy could avoid national efficiency losses that could arise with lobbying in a democratic system.

International Trade Theory and Policy - Chapter 120-5D: Last Updated on 7/19/97