In a previous article, I outlined how it is easy to prove mathematically that quotas reduce overall welfare, because the cost to consumers overwhelms the benefits gained by domestic firms. Given this fact, and that the benefits are more spread out, one would initially expect that free trade policies would be universal, at least in democracies. But this is hardly the case. A look at the news over the past decade is evidence of the mixed record of the world when it comes to free trade. Steel tariffs, French cheese protection, and import substitute industrialization are all examples of protectionism trumping protectionism. In this article I will argue that this empirical result can be explained by the distributional effects of free trade and their interactions with the different domestic institutions of nations. I will approach this explanation in a game theoretical context.
What was obvious from the previous article was that the total consumer welfare loss was greater than the total producer welfare gain. However, with almost every good that is produced, the number of consumers greatly outnumbers the number of producers. As a result, the per person consumer welfare loss will be far less than the per firm producer welfare gain. In other words, protectionism concentrates benefits and spreads out costs, and free trade spreads out benefits and concentrates costs.
As a result, consumers face a free rider problem. Any consumer lobbying group will then have to overcome steep cooperation problems. Because any one consumer has a strong incentive to defect, as his single deviation will not usually change the outcome of any lobbying effort. Alternatively, if a person is the only person paying the lobbying cost, even if victory is achieved, the benefits to that individual will likely not even come close to the lobbying costs.
This means that consumers face a prisoner’s dilemma. It can be modelled by:
|All Other Consumers|
|Individual Consumer||Lobby||Not Lobby|
Because this is a multiple person game, I have aggregated all consumers besides the test case being examined. As a result, this model does not appear to be a prisoner’s dilemma. However, as can be seen, for any individual consumer not lobby dominates lobby regardless of the actions of everyone else acting as a unit. It can then be reasoned that not lobbying will be the equilibrium for everyone, and the consumers are stuck in a position where they would be all better off if they could insure cooperation.
For firms, the situation is much more likely to be a stag hunt. Individual contributions to lobbying will make a difference in the end result, even if all other firms are assumed to be acting as a single unit. This is even more likely to be the case when a country has regional electoral districts that subdivide the country, like US Congressional Districts. Smaller sub-regions will have fewer competing firms in an industry, and politicians elected from these regions are more likely to care about these firms because they employ a large portion of the local population.
Empirically, there are many implications of the model I presented before. The first is that countries with many electoral districts will be more likely to undertake protectionist policies, and countries with large districts, like Israel, will be more likely to favor free trade. Additionally, politicians elected from broader bases of supporters will be more likely to support free trade. This is likely why the president of the United States has historically supported free trade more than individual congressmen.
In a future article, I will explore the implications that information access has on free trade.