While the literature on trade negotiations typically assumes that governments are benevolent servants of their national interests, it is also well understood that the outcomes also reflect domestic political pressures. In Discussion Paper No. 806, Research Fellows Gene Grossman and Elhanan Helpman develop a two-country model in which politicians' objective function in international negotiations is determined by their need to satisfy competing special interest groups (which provide campaign contributions) and to minimize the loss of per capita real incomes (and hence popular support) resulting from inefficient, protectionist policies.

In a non-cooperative setting, each government takes the other's policies as given and ignores how its own policies affect foreign factor owners and politicians. Organized import-competing industries offer campaign contributions in exchange for protection. Terms-of-trade considerations require positive tariffs, which are highest for industries with the least elastic foreign export supplies and domestic import demands. Export industries may face an export subsidy or tax. The latter becomes more likely, the lower is either the ratio of domestic output to domestic consumption or the foreign import demand elasticity.

In a cooperative setting, governments enter trade talks if they expect domestic special interests to reward them for securing export industries access to foreign markets and reducing support to foreign firms in the domestic market. Incumbent politicians can always reach an agreement that yields mutual gains relative to the `trade war' equilibrium. If lobbies in both countries are equally able and willing to bid for policy support, both countries' domestic prices will be the same as under free trade. An interest group's willingness to bid for import protection or export promotion reflects its stake in the policy outcome, while the cost of its securing policy support reflects the deadweight loss of a given trade distortion and politicians' concern for aggregate welfare. Industry lobbies that are politically stronger than their foreign counterparts will secure exceptions from across-the-board tariff cuts or reductions in export promotion.

Trade Wars and Trade Talks
Gene M Grossman and Elhanan Helpman

Discussion Paper No. 806, May 1993 (IT)