International Trade Theory and Policy
by Steven M. Suranovic

Trade 105-0

Political Economy and Trade - Overview

In most economic models, it is assumed that consumers maximize utility, firms maximize profit and governments maximize national welfare. Although one can reasonably object to any one of these assumptions, perhaps the one least likely to hold is the assumption about government's behavior. Governments are rarely comprised of a solitary decisionmaker whose primary interest is the maximum well being of the nation's constituents. Such a person, if he or she existed, could reasonably be labeled a "benevolent dictator." Although, in history, some nations have been ruled almost singlehandedly by dictators, most dictators could hardly be called benevolent.

The assumption that governments behave as if they had a benevolent dictator may have developed out of the philosophical traditions of utilitarianism. Utilitarianism, whose roots date to writings by Jeremy Bentham in the early 1800s, suggests that the objective of society should be to produce the greatest good for the greatest number. The objective of individuals is to obtain utility (aka, happiness, satisfaction, well-being, etc). In economic analysis we presume that individuals obtain all of their utility from the consumption of goods and services and this motivates the behavioral assumption that consumers maximize utility. The assumption that firms maximize profit is based on the same logic. Profit affects the income of firm owners. The greater one's income, the greater will be one's consumption possibilities and thus the higher will be one's utility. Thus profit is merely a means to an end, the end being greater utility. It is not unreasonable then, that if the objective of individuals, and firms, is maximum utility, the objective of a government might be to maximize utility for everyone.

But, even if governments do not seek to maximize national welfare, it is still a valid exercise to investigate which policies would lead to a maximum. Indeed, most of the analysis of trade policies does just this. Policy analysis identifies the differential welfare effects of various policies and points out which of these will lead to the greatest overall utility or welfare.

If one proscribes policies which also maximize national welfare, then one is making the value judgement that maximum national welfare is the appropriate goal for a government. If one presumes that governments do indeed seek to maximize national welfare, then the task is to explain why the choices that governments do make are explainable as the outcome of a national welfare maximization exercise. An alternative approach is to consider other reasons for the choices made by governments. This is essentially the task of political economy models.

Political economy is a term that reflects the interaction between the economic system and the political system. Many traditional models of the economy make simplifying assumptions about the behavior of governments. Keeping the model simple is one reason for the assumption of a benevolent dictator. Political economy models attempt to explain, more carefully, the decisionmaking process of governments. Today, most governments can be best described as representative democracies. This means that government officials are elected, through some voting procedure, to "represent" the interests of their constituents in making government decisions.

The key issue in political economy and trade models is to explain how political features in democratic economies affect the choice of trade policy. Among the key questions are:

1) Why do countries choose protection so often, especially given that economists have been emphasizing the advantages of free trade for 300 or more years? In other words if free trade is as good as economists say, then why do nations choose to protect?

2) In discussions of trade policy, why is so much attention seemingly given to the policy effects on businesses or firms, and so little attention given to the effects on consumers?

3) Why do political discussions, even today, have a mercantilist spirit, wherein exports are hailed as beneficial while imports are treated as harmful to the country?

International Trade Theory and Policy - Chapter 105-0: Last Updated on 3/3/01