Tariff determination in general equilibrium : a bargain-theoretic approach to policy modelling

Abstract

Government policies with redistributive implications have been a source of many social and political conflicts. Until recently, positive economics has lacked a consistent analytical framework that could explain how such policies are formed and how they respond to exogenous shocks. This study makes a contribution towards this direction by offering a consistent theoretical framework for short-run policy modelling. Assuming that tariff rates are the only available instruments of a government’s redistributive policy this study addresses the following two specific questions: (i) how the tariff rates are determined; (ii) and how do they respond to exogenous shocks? To answer these questions, a general equilibrium model of a political economy is developed by combining a model of the political sphere with a Ricardo-Viner type model of the economic sphere. Policies are determined by strategic interactions between government and the conflicting interest groups in the political sphere which, in turn, determine the welfare of the interest groups in the economic sphere and political support for the government in the political sphere. The conflicting interest groups may spend resources in predatory political activities or may choose to cooperate. A general equilibrium of the political economy is obtained when both the political and the economic spheres are simultaneously in equilibrium. Under fairly general conditions, it is shown that at least one equilibrium exists in a political economy whether it exhibits cooperative behaviour in the political sphere or not This study has employed the analytical framework of cooperative-bargaining theory in obtaining a general equilibrium model of the political economy. This approach is taken because a noncooperative equilibrium is not necessarily Pareto efficient Several interesting results follow from the comparative static properties of the model. In particular, it is shown that: (i) the import-competing sector receives increased protection if the relative price of the home importable falls in the world market; (ii) the protection afforded to a particular sector declines if the domestic endowment of factors moves in favour of that sector, and (iii) so long as the distribution of relative bargaining power remains unaffected by the shocks, the response of the tariff rate to the shocks will be independent of the distribution the bargaining power. These analytical results are very similar to ones that follow from the maximization of a conservative social welfare function. The implications are that: (i) a government’s redistributive policy could be modelled as an equilibrium outcome of a bargaining process between the organized interest groups holding conflicting interests on the level of the redistributive policy; and (ii) the bargaining process may be viewed as the mechanism of generating a conservative social welfare function. The self-interest, and public-interest approaches in policy modelling can thus be reconciled.