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The Political Economy of Trade Policy


Most countries’ defense of free trade principles has been an integral part of the economic theory and this has been one of the areas that most economists agree on. Since the 1980s, the world economy has moved towards free trade and most countries have chosen to unilaterally liberalize their trade policies. There have been exceptions to the argument for free trade like in the case defending infant home industries and also ‘the new trade theory’ but in most cases this type of protectionism have little relations to these expectations. Pressure to grant protectionism has been has been a source of frustration to international economists which arise due to tying to warrant it on grounds of national economic interest. This paper will thus identify the contract between trade theory and trade policy reality and give explanations for the cause of this kind of situation.

International trade theory

The international trade theory identifies the conditions, the causes and the effects of the international trade amongst the world countries. The theory deals with international trade’s impact on a country’s economic growth and the income distribution within the country and the country’s international location of production factors.

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The theory of protectionism postulates that protectionism is based on mercantilism who advocates for a balance of trade surplus and thus measuring the growth of wealth in a country. The mercantilist trade policy later led to protectionism which is based on import limitation and export subsidization by placing high import tariff rates, export monopolies and export subsidies. The theory of protectionism was majorly supported by Thomas Mun who actively supported the idea of active trade balance. Unlike other mercantilists though, Thomas refused the strict prohibition of gold export from a country. In his view, he supported gold export as long as there was guaranteed larger influx of gold than the volume of primary efflux. People like Alexander Hamilton supported the development of protectionism and his approach was that of ensuring use of grants and subsidies. Hamilton’s view was that governments should ensure temporary protection of a domestic policy from outside competition. He alleges that these industries will increase production volume and as a result produce cheaply like the industries from foreign competitors. Another economist, Friedrich List advocated on Hamilton’s the exercitation of trade protection on grounds of different level of maturity of international exchanges. He attributed the different level of maturity as influencing the mutual trade in a country’s transformation processes. List postulated that it was necessary to build a large market to enable the industry to achieve economies of scale and as a result become more competitive opening the domestic markets to foreign competition. The argument on infant industry argument is the main reason for intervention into free trade as opposed to just increasing a country’s wealth.

For the past two decades as argued earlier, the proposition about free trade has been that in most circumstances it has been highly beneficial and that countries that will adopt it may highly benefit from it apart from the protectionism frustration. This has resulted to many economists turning their attention to understanding the political economy of protection. In this light, effort has been made to estimate the protection determinants (trade barriers) which may include the following; level of employment, the industry’s trend and its profitability, import rate and its level of penetration and geographical location of the industry. In America for example, the political economy of the American is designed in such a way that it enriches the understanding of the political economy by filling the gap first. The reason is to have the process of seeking protection and that of conferring the same for a number of American industries.

Analyzing the political economy of protection

In most circumstances, protection is seen as economically inefficient way in achieving any objective. Due to this, there should be a satisfactory theory for supporting the political economy of protection. In this respect we will look at the modern theoretical approaches to international trade theories.

Modern theoretical approaches to international trade

J. Keynes was more inclined to the mercantile theories due to trade balance surplus which ensures employment solving the propensity to consume insufficiency. Since the 1980s many economists have tried differentiating between free trade and international trade. New trade theory was more particularly put forward by PR Krugman and J. Bhagwati. Krugman had the view that imperfect competition in international trade as a consequence of economies of scale. He argued that for large firms, they had the advantage over small firms especially when profit increases.

The strategic trade policy that occurred in the 20th century is to justify the use of industrial policies for the benefit of high-tech industries.  It postulates that government intervention can greatly be of help to local industries to achieve economies of scale thus becoming more efficient and competitive in the global scale especially with most economies now globalized. According to Krugman, gains made from these trade policies can be enormous but “are limited by uncertainty about appropriate policies, by entry that dissipates the gains, and by the general equilibrium effects that insure that promoting one sector diverts resources from others. The combination of these factors limits the potential benefits of sophisticated interventionism”.

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According to another economist, J. Bhagwati, he defends free trade with respect to environmentalism and refused the idea that free trade harms the environment.  He supports the multinational approach to international trade. He argues against bilateral and regional free trade as according to him they ‘put chaos into the world system.’ He further argues that free trade has a positive effect if the price mechanism works perfectly and prices reflect the real price in the markets. But to understand all these, we need to have a view of what trade and trade policy are.

Trade and trade policy

During the World War II most LCDs used trade barriers especially for the purpose of ISI. But towards the 1980s many countries especially the developed ones had began to liberalize trade and adopting export oriented policies.  An international trade affair in Uruguay promoted this by reducing trade barriers in key interest areas while the WTO induced other countries to join. In the 1990s, most countries transformed from communist states to market based countries further accelerating the trend of global trade liberalization. Since then, the growth of world trade has surged and the regionalization of trade as well.

Reality of international trade

Although countries advocate for free trade, the reality of international trade and how it is played out is different. Some countries do divert from free trade and an example is Britain whose protectionism represented the Navigation Acts and the Corn Laws which were repealed in 1846 but the post-war trade liberalization was later connected with both the multilateral and bilateral trade agreements on free trade zones. Since the mid-20th century and more so in the 1990s, many free trade agreements have come up and in relation with the free trade areas, there is the problem of diversion or danger of trade warfare. In reality, the world trade has some protectionists and few countries like Hong Kong have absolutely free trade as world trade also fluctuates. In most liberalized developed countries, protectionism is used as an instrument of fighting unemployment. This especially follows Keynesian approach that tariffs could divert a country’s aggregate demand from domestic goods to foreign ones reducing employment as a result

Political argument for free trade

The politics behind free trade is that political commitment to free trade may reflect a good idea in practice despite some better policies in principle. Most economists are of the idea that trade policies in practice are usually dominated by special interest by politicians rather than considering national costs and other associated benefits. Economists can calculate and show in theory that a certain tariff and export subsidies can increase national welfare but in reality it is hard for any government agency to pursue such kind of sophisticated program due to some interest groups which could be used to redistribute income to other politically influential sectors. An argument like the above if correct then could be used to advocate for free trade without any barriers but then economically speaking, free trade may not always be the best idea.

Most international economists (especially that from the USA) postulate the three arguments presented below about free trade;

  • The agreed measured costs of deviating from free trade are big,
  • There are benefits that accrue from free trade that also include to the costs of protectionism and finally
  • An attempt to try sophisticated deviations from free trade may result in subverted by politics.

Despite all these there are some intellectual arguments for deviating from free trade.

The terms of trade argument for a tariff

One argument put forward for deviating from free trade is from the cost-benefit analysis. Some countries are large enough to affect the prices of foreign exporters and tariffs will lower the import prices and as a result generate a terms of trade benefit. The benefit should be set against the tariff costs which will arise due to tariff distorting consumption and production incentives. But in some cases, it is possible that free trade benefit terms may outweigh its costs. This will thus generate a terms of trade argument for a tariff.

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The demand for trade policy

Much of research about political economy of trade as we have seen earlier demands for the protection made by various segments of the society and many of the studies generally look at domestic institutions and policy makers as the passive actors who supply the trade policies as demanded by interest groups.  Busch and Mansfield argues that to address the effects of these interest groups, researchers begin by specifying the factors shaping individual’s preferences about trade policy relying on models drawn from the internat6ional trade policy.

Models such as the Heckscher-Ohlin assume factors of a country to be perfectly mobile across all the sectors. The model shows that free trade benefits owners of factors of production while hurting owners of scarce factors. An example is in the US which is more capital oriented, open commerce rewards to the players in this field while reducing wages for low skilled labor. Thus trade has the effect of increasing demand for skilled US employees; their wages will thus rise regardless of which sector they are employed in. according to this HO model, it anticipates it anticipates capital and labor cleavages over trade policy. 

The second model is the Ricardo-Viner (RV) model that postulates that in the short run some factors of production cannot be shifted to other sectors of production. Thus if the factors of production cannot be shifted from one sector to the other, the owners of the factors of production will then base their trade policy preferences on how open commerce will affect the industry and employment in general. Based on this assumption, then the factors of production (capital and labor) will be against free trade in imports sectors because they will both be hurt by foreign competition. The difference between the two models is that while the RV model envisions that cleavages over trade policy will form along the sectors of production the HO model postulates that they will form a long the spectral lines. Of the two models, many more studies endorse the HO model to be more useful. This can be explained that trade coalitions usually form along factoral lines which gives rise not only to class conflict but also rural-urban splits instead of conflicts between industries. However some studies endorse the RV model where preferences in the 1906 election mapped on the workers’ industry of employment.    

Case in point for protection

Protection of the US steel industry

A case in point is when the Bush administration levied hefty import tariffs on steel. The reason was to bail out outdated and inefficient steel producers in the US. The major effect according to economists was to stall the transformation of the US steel industry and sustain firms that were mired in debt. Weak steel makers as a result were likely to get enough relief to keep employees and the plants working. The tariffs in question thus were to weaken incentives for industry consultation. In this case, the Bush administration rewarded the powerful and unionized old steel industry mills (the ones in key electoral states of West Virginia and Pennsylvania) and offered less protection to the modern but non-unionized firms making the high end products like stainless steel.

An article in the wall street journal argued that the Bush administration had imposed the import protection in order to give breathing room to the domestic steel industry to upgrade their equipments and later as a result bring down its labor costs. It is thus clear that the benefits of free trade constitute of various types and as a result the costs of limiting trade must be high, that is to say that limiting trade will create more welfare loss than the net welfare loss due to production and consumption distortions. Thus the case for free trade is now made clearer by the above argument but as we had seen earlier, most countries do not hold this view in practice but their practices limit trade with other several tariffs and other non-tariff barriers.  According to finger, US’s steel import policy destroys 50 jobs in the rest of the economy for each one saved in the steel industry. He further argues that restrictions on auto imports added no jobs in the auto industry but only managed $2 billion each year from America to Japanese products.

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The political economy of US export subsidies for wheat

An article by Gardner states that the US agricultural commodities are predominantly exported rather than imported. But border price do exist for the exported goods in the form of export subsidies. In all these, there are economics and politics of export subsidies that focuses on the export enhancement program initiative started in 1985 (pg.261). Agribusiness and farm groups have always supported these kinds of programs. The interested groups (mainly charitable organizations and non-profit organizations) have questioned the negative impact of food aid on food production in the recipient countries. Despite all these, the groups have supported food aid in times of emergency.

The movement towards free trade

With the ideology about free trade, most people could be of the opinion that the [past and present industrialized world will try to make trade free of tariffs but surprisingly enough that is not the case. This is because the history of trade policies is shown to have few free trade periods and many longer periods of tariffs and a rise of non-tariff barriers. The modern story of trade policy and trade negations starts with the GATT. Before and after the World War II, the US and the Europeans had imposed stiff tariffs. The US for example imposed stiff tariffs in the Smooth-Hawley Act of the 1930s whose main aim was to keep imports out of the country while helping to encourage domestic production and help end the depression the country was experiencing by then. But some economists argued that the Act helped deepen the depression in the US. The argument is that the US lost the opportunity to export its goods to other countries because of the reduced effects of the tariffs. After WWII, GATT was established mainly to reduce tariffs around the world and 23 countries were among the first signatories.

GATT talks later in Uruguay culminated in the establishment of the WTO and the main agreements of the Uruguay constituted the following;

  • Trade liberalization; this discussed ending of agricultural subsidies and this required count6ries to cut export subsidies and convert import quotas into tariffs by 2003 and also ending non-tariff barriers.
  •  Institutional reform; the establishment of a dispute settlement mechanism (the WTO) which has the powers to adjudicate and impose penalty on wrong doing countries.

The domestic market failure argument against free trade

Apart from the issue of the terms of trade, the basic argument for free trade was on cost benefit and thus many economists have made a case against free trade. One such argument is the domestic failure against free trade, known as the second best theory. The theory states that a hands-off policy is only good in any market only if all other markets are working properly. For example if the labour market is not working properly and does not deliver full employment, then a good idea may be subsidizing labour intensive industries. When the second best theory is applied, the argument put forth by economists is that imperfections in the economy may justify interfering in its external economic relations.


We have seen that in an ideal world, it always seems that the political processes would lead to an outcome of an economically efficient or low cost fashion but again, that is not the case in a real world. We have seen cases that evidently show that there is no ideal world, may be apart from Hong Kong. There are political costs to economically solutions and thus important to understand how the process of protection works. From the perspective of political economy, themes emerge from analyzing individual studies which leads to supplementing of the political economy of protection. Findings from some selected individual studies (the automobiles, steel and wheat case) shed more light into this. For steel as foreign competition increased they sought relief through protection. They sought protection from through countervailing duties in response from foreign subsidies. Clearly, the US has a systematic interest in an open international trading system that outweighs any benefits achieved from individual affirmative findings.   

The question is why is it that the case for free trade and that of protection be made more effective. The case is better argued in broad international agreements than in where specific industries are located. But again world trade is tied to with some protectionism although international trade predicts that countries will prosper more when specializing on activities where they have a comparative advantage. But with the world being more globalized, it is hard to generally say whether integration will lead to free trade. But in principle, trade diversion is like protectionism as it enables formation of international trade by virtue of comparative advantage.