• Document: Choosing between Protectionism and Free Trade in an Uncertain World
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Choosing between Protectionism and Free Trade in an Uncertain World Peter Debaere1 , Toni Glaser2 , and Gerald Willmann2,3 1 Darden School of Business, University of Virginia 2 Bielefeld University, KU Leuven 3 IfW Kiel June 27, 2016 Abstract We develop a 2x2x2 general equilibrium model of trade with imperfect capital mo- bility, uncertain productivity in one sector, and risk-neutral producers chosing the capital allocation before uncertainty resolves. Without government intervention, the allocation of production is more export-oriented than what risk-averse consumers prefer. National welfare maximization hence justifies the use of trade policy. With uncertainty in both countries, a trade-off exists between trade as insurance against domestic shocks, and protection as insurance against foreign shocks. We find that the optimal trade policy depends not just on a country’s comparative advantage, but also on the size and the correlation of the domestic and foreign shocks it ex- periences. Our results are consistent with persistent protection in sectors such as agriculture. Keywords: trade policy under uncertainty, delayed structural adjustment. JEL Classifications: F13, F62. We thank for their comments Simon Miegielsen, Dan Murphy, Jo Van Biesebroeck, and Kieran Walsh, participants at the European Trade Study Group Meeting, Birmingham 2013, the Aarhus Kiel Work- shop, Kiel 2013, and seminar audiences at Bielefeld and Leuven. Toni Glaser carried out this work within the International Research Training Group EBIM (Economic Behavior and Interaction Models) financed by the DFG under contract GRK 1134/2. He would also like to thank the KU Leuven for their financial support. 1 1. Introduction Since World War II major progress has been made in liberalizing international trade and in undoing the crippling protectionism of the interbellum years. There is broad consensus among economists that free trade is in most cases both desirable and beneficial.1 It is thus puzzling to see that so many trade barriers persist. It is also striking that protectionism is most prevalent in agriculture. Worldwide, trade restrictions in terms of tariff equivalents remain with 24 % quite high in agriculture, and significantly higher than the 9 % of manufacturing.2 Consistent with this high level of protectionism in agriculture is a lower fraction of agricultural output that is traded worldwide than in manufacturing3 . While there is significant heterogeneity in countries’ protectionism, an interesting pattern can be discerned. Advanced economies tend to follow the European Union whose agricultural trade restrictions (33.6%) are above the world average, and below it in manufacturing (3.3%). Less well-off countries, on the other hand, are more likely to be less protectionist in agriculture than the world average and more so in manufacturing, see Figure 1. The lack of progress in the latest WTO trade liberalization round underscores there is limited willingness on the part of advanced and emerging economies to reduce protection for agriculture.4 To make matters even more challenging for the prospects of liberalizing trade in agriculture, there is the additional uncertainty that agriculture faces due to, on the one hand, increased water scarcity and continued population growth, and, on the other hand, a changing climate. In this paper we argue that under certain conditions a country as a whole may actually benefit from a certain degree of protectionism. There may be legitimate reasons related to the uncertainty that countries face that explain 1. why some advanced economies with a comparative advantage in manufacturing choose to impose tariffs in agriculture 2. why some less advanced economies with a comparative advantage in agriculture find it beneficial to favor manufacturing in terms of protection 3. why other countries choose to diverge from this pattern. 1 Kemp and Wan (1972), Dixit and Norman (1980), and Dixit and Norman (1986) show that free trade is potentially Pareto superior to autarky, and that it is possible to make everybody better off under trade, using several redistributive tools. For a survey that discusses the theoretical literature on gains from trade, see Facchini and Willmann (2001). For empirical evidence see e.g. Eaton and Kortum (2002). 2 Anderson and Neary (1996) and Anderson and Neary (2003) translate protectionist measures of different origin into an aggregate tariff equivalent measure. Kee et al. (2008) estimate those measures for over 100 countries, called International Trade Restrictiveness measures for agriculture and manufacturing. See for updated data at http://econ.worldbank.org/WBSITE/EXTERNAL/ EX

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