Theories of tariffs : trade wars, trade agreements, and political economy
This thesis is concerned with the general trade theoretic issue of what explains tariffs. Two possible theories are investigated: (i) the optimum tariff argument where countries exploit their market power to affect world prices, and (ii) the political economy argument, where well-organised interest groups who have a preference for the tariff protection level can influence their governments through lobbying. The main contribution of this thesis is the use of the many-country, two-good trade model, which can be found in the customs union literature, to investigate the importance of the (world) market structure on the welfare effects of tariffs. This model, where a good is exported by more than one country, allows us to examine the welfare effects of tariffs which vary with how the goods are divided initially among the countries. The theory of optimum tariffs and retaliation, usually in the two-country, two-good context, suggests that the country whose endowments of goods are relatively large tends to 'win' a trade war. Still, the analysis in this chapter shows that there is a greater possibility for a country to win even if the country's endowments are relatively small if the world market of its exportable moves closer to the monopolistic market, i.e. there are less countries exporting the same good and/or the world endowment of that good is divided more disproportionately among its exporters. An important feature of the many-country, two-good trade model is that tariffs are strategic complements between countries that have the same trade pattern and are strategic substitutes otherwise. Therefore, two possible trade agreements can be investigated: (i) an agreement between countries whose tariffs are strategic complements, and (ii) an agreement between countries whose tariffs are strategic substitutes. Since these trade agreements imply different sources of gain for a country (gain from an improvement in terms of trade for the former and gain from an increase in volume of trade for the latter), this thesis examines the choice of a country by comparing the welfare implications between the two possibilities. It is found that a country would prefer to have a trade agreement with the country whose endowments of goods are relatively large regardless of the strategic complementarity or substitutability of their tariffs. Finally, this thesis attempts to endogenise the lobby formation by modelling an individual's decision to participate in lobbying prior to the stages of interaction between a government and lobbies studied by Grossman and Helpman (1994). It is found that no one lobbies individually in equilibrium if the total population and/or the fixed cost of lobbying are too large. An incentive that leads individuals to form a lobby is the ability of the group to restrain the individuals' otherwise offsetting lobbying efforts. An interesting result is that, in equilibrium, some individuals might choose to join the lobbies that lobby against their interests to moderate their efforts rather than to join the lobbies that lobby in their favour. This result raises a question whether the standard industry-lobby in the literature might exaggerate the actual lobbying activities.