The Political Economy of Protectionism and Industrial Policy

Abstract:     
This paper develops a model of trade and industrial policy where the politicians in charge of the government can direct the rents generated by their policies toward their political or economic objectives through different channels: lobbying, taxation, regulation, and tariff and quota allocation. Different mechanisms are distinguished by their point of rent extraction and differences in resource waste for each dollar of transfer. In conjunction with industrial policy, specific asset formation is also endogenized. We show that many characteristics of the model's equilibria transcend specific channels of rent extraction that prevail. The parameters that represent the effectiveness of rent transfer through various channels play a mediating role. The results show that the relationships between these parameters and policy outcomes may be different from those based on single-channel models. We show that under reasonable conditions, a variety of parameter changes induce a positive relationship between the restrictiveness of policies toward domestic and foreign competition. This helps explain a number of important empirical regularities such as the positive association of protection with import penetration and output-capital ratio. The model also offers a guide for empirical research on the role of lobbying and other rent extraction mechanisms in policy-making.

JEL Classifications: F13, L52

Working Paper Series