G-SEC WORKING PAPER No.4
Cross-Border Political Donations
and Pareto-Efficient Tariffs
Masahiro Endoh *January, 2006

Abstract
This paper examines the effects of lobbying activities across international borders, on
determining each country’s import tariff in a multi-principal, multi-agent, menu-auction model.
Cross-border political donations could promote international policy cooperation because of twoof their distinctive characteristics.

First, special interest groups use cross-border donations as

tools to wield their influence on ruling parties of other countries directly, which promotes
efficiency of policy formation.

Second, for ruling parties of countries, cross-border donations

make them take into account the impact of their policy on other countries, which makes themmore sensitive to other countries’ welfare and, therefore, more cooperative with others.

Whenruling parties estimate the worth of political contributions from national special interest groups
and from foreign lobbying groups with the same weight, Pareto-efficient tariffs are attained atwhich world welfare is maximized.

* Faculty of Business and Commerce, Keio University, Mita 2-15-45, Minato-ku, Tokyo, 108-8345, Japan.

Phone: +81-3-5427-1277, Fax : +81-3-5427-1578, E-mail: endoh@fbc.keio.ac.jp

1. Introduction
Foreign donations to domestic political parties are generally considered to be harmful toa nation’s independence.

The climate of public opinion around the world with regard to

cross-border political contributions is gradually but continuously strengthening to the point thatwould demand the delegitimization of accepting such donations. In fact, after the 1990’s, somecountries, such as Canada, the Czech Republic, the Russian Federation, the U.K. and Singapore,revised their regulations regarding political funding in order to prohibit national political parties
from accepting contributions from foreign sources.

In Canada, The Canada Elections Act wasamended in 1993 to prohibit candidates and parties from receiving campaign contributions fromabroad.

In the U.K., The Political Parties, Elections and Referendums Act 2000 was enacted,

aiming to regulate political donations, including a ban on foreign donations. The prevailing
opinion among these countries is that foreign campaign contributions threaten their right tomaintain their sovereignty, determine their own laws, and elect their own officials, free of outside
interference. 1
These negative circumstances for foreign political donations don’t mean, however, thatthe topic is not worth considering. Rather, it is possible they could promote international policy
cooperation in two ways. First, if the donors of political contributions are permitted to give
donations to foreign countries, they could use their donations as tools to wield their influence on
ruling parties of countries directly, which would promote efficiency of policy formation.

Second,the ruling parties of countries, recipients of political contributions, would take into account the
impact of their policy on other countries, which would make them more sensitive to othercountries’ welfare and, therefore, more cooperative with others.

I explain these two benefits ofcross-border political donations in this paper, taking import tariffs as an example. When rulingparties estimate the worth of political contributions from national special interest groups andfrom foreign lobbying groups with the same weight, Pareto-efficient tariffs are attained at whichworld welfare is maximized.

This result implies that cross-border political contributions per se

are not harmful for the formation of cooperative economic policies.
My economic analysis of political donations from abroad is inspired by two observations.
First, two papers presented figures that show that foreign lobbying had a significant impact on
the trade policy of the U.S.

The pioneering work of Gawande, Krishna, and Robbins (2004)

empirically demonstrated that in the years 1978 - 82, the presence of an organized non-U.S. lobby
representing a particular industrial sector had as much effect on lowering tariffs against imports
in that sector as did the presence of a U.S. lobby in raising tariffs there.

Kee, Olarreaga, andSilva (2004) also showed that lobbying expenditures in the U.S. by Latin American exporters area significant determinant of tariff preferences granted by the U.S. in the years 1997 - 2000. 2
Seeing the positive effect of foreign lobbying activity on U.S. trade policy, it is natural to extend it
to consider the case of “multilateral lobbying,” that is, the combined case of domestic lobbying
activities and two-way cross-border lobbying activities both from the home country to the foreign1and from the foreign country to the home.
A second observation is that some scholars of international law found positive aspects offoreign donations in their research.

Damrosch (1989) concludes that nonforcible politicalinfluence, including political funding which comes from foreign sources, has the potential both forenhancing internationally protected human rights and for promoting constructive, nonviolent
relations between states, with the condition that it doesn’t prevent the people of another statefrom exercising their political rights and freedoms.

As for research focusing more on theeconomic aspect, Powell (1996) asserts that foreign corporations have a legitimate right to express
their interests in some manner, since they have a significant interest in the domestic policies ofother countries.

He argues that the international community should direct its attention to

attacking international bribery, instead of instituting blanket prohibitions against all types offoreign campaign contributions.

My research complements these arguments from the point ofview of economics, showing that foreign donations would make trade policies more cooperativeinternationally.
It is curious to see that the significance of foreign donations to domestic political parties
has almost been neglected as a subject of economic research until recently, with the exception ofGrossman and Helpman (1995a, 1995b) and Hamada (1993).

Grossman and Helpman (1995a)

compare the case in which lobbies can contribute to other country’s politicians as well as to theirown national government with the case in which cross-border contributions are not permitted,
and indicate that the size of the tariff response to any given tariff of other country in the formercase is lower than that in the latter case.

This theoretical finding implies that cross-border

political donations have a potential to make international trade freer. Grossman and Helpman(1995b) also analyze the conditions under which a free trade agreement could be concluded by two
small countries in the case when politicians were permitted to accept donations from abroad.
They found that the conditions in the case permitting cross-border donations could be more or lessstringent than the conditions in the case prohibiting them, depending on the circumstances.
Hamada (1993) considers the situation where one home lobby gave a political contribution inorder that its home government would protect its profit, while one foreign lobby also donated tothe home government in order to pressure it for free trade. In his setting, permitting a foreign
donation would increase the national welfare of the home country.

My paper extends theirarguments in order to consider the possibility whether two-way lobbying across borders would
help to attain Pareto-efficient tariffs in a general way by employing the theoretical foundation ofGrossman and Helpman (1994, 1995a, 1995b).
Readers might consider my research target to be exceptional cases if we assume that theban on accepting political donations from abroad is dominant in the world.

In fact, politicalfunding laws differ from country to country in their approach to foreign contributions.

It is truethat some large countries, the United States (U.S.), Canada, the United Kingdom (U.K.), France,
and Japan, for example, have laws against foreign donations.

There are, however, othercountries that tolerate such donations explicitly or implicitly.

Germany, the Scandinavian

2countries, Australia, and New Zealand, for example, permit their national parties to accept
donations from abroad. Switzerland and Austria, proud of their permanent neutrality, admit
foreign donations.

According to Austin and Tjernström (2003), among 111 countries which are

categorized as “free” and “partly free” concerning political rights and civil liberties in the 2002
Freedom House Index, and whose data are reported, only about one third (40 countries) haveregulations totally banning political donations from foreign sources.
Table 1 classifies the number of countries which totally ban foreign donations by income
and by region, reported in Austin and Tjernström (2003). This table shows that national income
and per capita income of a country have little to do with whether that country admits or banspolitical donations from abroad. As for income, high national income countries and high per
capita income countries don’t necessarily totally ban political donations from abroad.

Among 29

countries whose national GDP is more than 100,000 million US$, fewer than half totally ban
foreign donations, and among 28 countries whose GDP per capita is more than 10,000 US$, only
about two fifths do. As for regions, the ratio of the number of countries which admit to someextent foreign donations to the number of countries which don’t at all varies from continent tocontinent; it is half or more in Asia and Europe while less than half in Africa, the Americas, andOceania.

Each of them, however, has a significant number of countries which permit national

parties to accept foreign contributions.

Countries which tolerate foreign donations are neither

exceptions nor symbols of underdevelopment. They are dispersed throughout the globe.
Previous achievements in economics provide us with tools to analyze this problem.

I

employ the notion of truthful strategy introduced by Bernheim and Whinston (1986). With themulti-principal, one-agent and first-price menu-auction model, under the assumption of complete
information, they show that a truthful Nash equilibrium is always efficient and stable.
Grossman and Helpman (1994) apply this equilibrium concept in a model of endogenous policy
determination.

Their reformulation of Bernheim and Whinston (1986) provides us a tractable

way of thinking about the influence of lobbies on their government’s policy decisions.

The

theoretical analysis of “multilateral lobbying” needs truthful strategy in a multi-principal
multi-agent model, which was to my knowledge first proposed by Grossman and Helpman (1995a,
1995b, 1996) in a certain environment, and later by Prat and Rustichini (2003) in a more generalcase.

The concept of weakly truthful equilibrium by Prat and Rustichini (2003) preserves thedesirable characteristic of efficiency, which my results rely on.

Although they don’t consider

strategic interdependency between agents, my model shows that, under certain circumstances,the efficient equilibrium is attained even under the existence of strategic relationships.
Various papers have investigated how to establish efficient trade policies and ensure
freer trade, given the absence of a supra-national authority to enforce the terms of agreements
concerning tariffs.

Previous research is mainly divided into two groups.

The first one examined

the role of the General Agreement on Tariffs and Trade (GATT) and the World Trade Organization(WTO) to promote self-enforcing efficient tariff regimes.

Dixit (1987), Bagwell and Staiger(1990), Riezman (1991), Maggi (1999) and Ederington (2001) treat GATT/WTO as a forum for3

repeating negotiation with the threat to retaliate for violation.

Bagwell and Staiger (1999)

evaluate the reciprocity principle of the GATT and find that it can assist governments inachieving efficient policy outcomes by eliminating the terms-of-trade effect of protection.
The second group looked at the noninstitutional interdependency of decision-making
between economic activities as a tool to decrease tariffs endogenously. Devereux and Lee (1999)
examine the interaction between international financial markets and trade policy, and find that
free trade tends toward equilibrium when international financial markets are fully diversified.
Krishna and Mitra (2005) discuss the idea that unilateral tariff reduction by a large country can
induce a trading counterpart to reduce its tariff in return, with the model of endogenous lobby
formation. Blanchard (2005) shows that export-platform foreign direct investment (FDI) induces
unilateral tariff liberalization by the FDI-source country, suggesting that international capital
mobility may substitute for multilateral trade liberalization.

Limão (2005) analyses the linkageof retaliation between trade policy and environmental policy, and shows that if they are strategic
complements then policy linkage can sustain more cooperation in both issues than no-linkage.
This paper belongs to this group; I propose “multilateral lobbying” as a new tool to attain
Pareto-efficient tariffs.

Using multilateral lobbying the conditions for Pareto-efficiency are clear

and simple.
The organization of this paper is as follows: Section 2 presents the basic economic
structure of two countries involved in trade with each other.

Section 3 considers domestic

lobbying activities by national special interest groups, which propose their schedule of donations
to the national ruling party.

Section 4 takes cross-border lobbying activities into accountadditionally in the model. Section 5 examines the conditions in which the permission of bothkinds of lobbying leads the economy to Pareto-efficiency and the sum of the two countries’ welfare
is maximized.

Section 6 extends the model to the case of nonpecuniary negative externality.

Finally, Section 7 concludes the paper and presents policy implication.

2. The Model
Consider a two-country multi-good general equilibrium model of trade. Two countries,
home (no *) and foreign (*), produce and trade competitively N+1 goods. 3

Good 0 is a numeraire

good, which is traded freely across countries and serves to settle the balance of trade.
Numeraire good 0 is produced by labor alone, with constant returns to scale.
that a world and domestic price of good 0 is equal to one.

I choose units so

It is assumed that aggregate labor

supply, L , is large enough to sustain a positive output of good 0.

This implies that wage rates innumeraire terms are equalized to one across countries.
Each of the non-numeraire goods i = 1, 2, …, N is produced by labor and a sector-specificinput, with constant returns to scale.

Specific inputs are available in inelastic supply.

Rulingparties (RPs) in the home and foreign countries use a vector of specific import tariffs4τ = (τ 1 ,...,τ N ) as a policy instrument. The local price of good i in terms of the numeraire good 0
is thus given by pi = piw + τ i , where piw is the world price 4 .

With a wage rate equal to one,the total rent Ri accruing to the specific factor in sector i depends only on the local price of thegood, and thus can be expressed as Ri ( pi ) .

Industry supply is then given by Yi ( p i ) = ∂Ri ∂pi .

The country is populated by a number of H individuals, who have identical preferenceswith their utility functions taking the following form:N(1)

u (c0 , c1 ,..., c N ) ≡ c 0 + ∑ u i (ci ) ,i =1

where c0 and ci are the consumption of numeraire good 0 and non-numeraire good i,
respectively.

u i (ci ) is assumed to be twice differentiable, increasing, and strictly concave.

Provided that income always exceeds expenditure on the nonnumeraire goods, thedomestic demand for good i can be expressed as a function of local price alone, i.e., Di ( pi ) .
import demand is then M i ( pi ) = Di ( p i ) − Yi ( pi ) .

Net

The world untaxed price, piw , is determinedby the market-clearing condition:
(2)

(

)

M i (τ i , p iw ) + M i* τ i* , p iw = 0 .

From Equation (2), we can derive an expression for world equilibrium prices as a function of the()

policies in the two countries, i.e., p iw τ i ,τ i* .
Domestic welfare is defined as the total amount of labor income, rent, tariff revenue, andconsumer surplus. 5
(3)

H
N
N
⎡H
⎤
W τ ,τ * ≡ L + ∑ Ri (τ i ,τ i* ) + ∑ τ i M i (τ i ,τ i* ) + H ⎢∑ u i ci τ i ,τ i* − ∑ p i ci τ i ,τ i* ⎥ .
i =1
i =1
i =1
⎣ i =1
⎦

(

)

( (

))

(

)

The RP in each country sets its import tariff as a policy instrument in order to maximize
its objective function.

In the case in which the RP doesn’t accept any donations, it is assumed totry to maximize its domestic welfare in order to enhance political support from the domestic
electorate and ensure that it will stay in power after the next election. Therefore, the objectivefunction of RP, G N(N to the upper right denotes “no donations”), is described as

5

(

)

(

)

G N τ ;τ * ≡ W τ , τ * . 6
When each RP sets its tariff unilaterally to maximize its domestic welfare, taking thetariff of the other country as given, the first-order conditions for maximization of the RP’s
objective function is defined by(4)GτNi ≡ Wτ i ≡ M iφi + τ i∂M i(1 − φi ) = 0 ,∂piwhere − φ i ≡ ∂p iw ∂τ i , 0 < φi < 1 .

GτNi and Wτ i represent the partial derivative of the RP’s

objective function ( G N ) and domestic welfare ( W ) with respect to the tariff on good i ( τ i ),respectively.

(5)

From Equations (2) and (4), the reaction function of τ i can be expressed as

τ iN (τ i* ) = −

piφ i
pi*
=
,
ε iM (1 − φi ) ε iM *(where ε iM ≡ (∂M i ∂p i )( p i M i ) and ε iM * ≡ ∂M i* ∂p i*) ( p M ) are the home and foreign
*
i

*
i

price elasticities of import demand or export supply, depending on whether M i is positive or
negative. Equation (5) is a familiar expression of optimal tariff, coming from the monopoly
power to change the terms of trade.

When the home country is the exporter of good i, forexample, ε iM > 0 and ε iM * < 0 , then τ iN < 0 , which means the home country levies positive tax
on the export of good i.

(

The changes of τ i and τ i under the condition of satisfying Equation*(5) is denoted by dτ i dτ i*

) , and the case (dτ dτ ) > 0 is considered hereinafter. Also, I
R

i

*
i R

assume a set of Equation (5) and the corresponding equation for the other country has a uniqueand stable equilibrium.

3. Domestic Lobbying
In this section, I examine the situation in which the RP accepts political contributions
from domestic special interest groups (SIGs) only.
formed by its people.

The country has K domestic SIGs which are

The welfare of j-th SIG is Wj(τ ,τ ) , j = 1, 2, …, K. Neither the*

preference of each SIG for tariffs nor the number of constituent members of it matters.
6

There

are two critical assumptions about SIGs which I accept hereinafter.

First, SIGs are wellorganized in both countries, and all the individuals belong to just one of the domestic SIGs, that is,

W = Σ jW j . 7 This assumption assures that there is no free-rider of political activities and also
avoids double-counting of individuals’ welfare.
differentiable and strictly concave.
K(6)

Second, W j

is assumed to be twice

These assumptions assure

KWτ i = ∑Wτ i , Wτ * = ∑ Wτ *j .
j

i

j =1

j =1

i

Each SIG decides its amount of donation to the national RP, which is in the position to
set policy, in order to maximize SIG’s welfare. The SIGs are assumed not to contribute to any
opposition parties.

The RP, on the other hand, chooses τ to maximize a weighted sum of

donations from national SIGs and net aggregate national welfare after deducting donations, with

τ * as given. This decision-making process is analyzed as the following two-stage game. First,
each SIG chooses its own bilateral contract schedule, which is publicly observable, simultaneously
and noncooperatively.

j-SIG in the home country offers a schedule of tariff vector, τ , and theamount of donation, C

Dj, to the RP (D to the upper right denotes “domestic donations”).

contract schedule can be rewritten as C

Dj

The

(τ ,τ (τ )) = C (τ ) , since each SIG predicts correctly*

Dj

how the shift of our τ causes the other country to change τ * , based on the corresponding
Equation (5) for the other country. Second, each RP decides whether to accept or reject the SIGs’
offers, and then chooses τ (for the RP in the home country) or τ * (in the foreign country),
simultaneously and noncooperatively.
contribution from domestic SIGs, G(7)

D

RP’s objective function under the circumstance of existing(τ ;τ ), is
*

K
K
⎛
⎞
G D τ ;τ * ≡ (1 − α )⎜⎜W τ ,τ * − ∑ C Dj (τ )⎟⎟ + α ∑ C Dj (τ ) .
j =1
j =1
⎝
⎠

(

)

(

)

The first term of the right-hand side is the weighted net welfare of the economy, i.e., the welfare
after deducting the total amount of domestic donations, while the second term is the weighted
total amount of domestic donations collected by the RP.

The condition 1 2 < α ≤ 1 is assumed inorder that the RP values campaign contributions positively and, therefore, accepts them.
I solve this two-stage game backwards.
maximize its objective function.

At the second stage, the RP decides τ to

Differentiation of Equation (7) with τ i creates the following

first-order condition for maximization of objective function for the RP.

7

K

GτDi ≡ (1 − α )Wτ i − (1 − 2α )∑ CτDji = 0 .

(8)

j =1

Next, at the first stage, SIGs choose contract offers.

To calculate the equilibrium ofcontracts, I employ the idea of “truthful” equilibrium in Bernheim and Whinston (1986), which isapplied to a model of endogenous policy determination by Grossman and Helpman (1994).
Truthful equilibrium needs to be jointly efficient for SIGs and the RP.
that GD

Joint efficiency means

is maximized, subject to constraints on the levels of each SIG’s welfare anchor, W j .

In equilibrium, the following equation is satisfied concerning the contract schedule of j-SIG. 8
(9)

(

)

C Dj (τ ) = W j τ ,τ * − W j .
Each SIG decides the menu of monetary contribution to the national RP and the requestof its tariff vector under the constraint of Equation (9).

That is, in truthful equilibrium ofcontract offers, the following condition is satisfied for each SIG.
(10)

dτ i*
.
i
dτ i R*CτDji = Wτ ij + Wτ *j

This equation means that, in the first stage, each SIG correctly predicts the reaction of the other(country’s tariff ( dτ i dτ i*) ) and takes it into consideration when it proposes its schedule ofR*

Substitute Equation (10) into Equation (8) and use Equations (2) and (6), and the

donation. 9

first-order condition for maximization of objective function for the RP is expressed as Equation
(11).
(11)

dτ i*
= 0,
i
dτ i R*Wτ i + ϕWτ *where Wτ * = (M i − τ i ∂M i ∂p i )φ i*i(functions τ iD τ i* , αand

ϕ = (2α − 1) α .

Equation (11) defines reaction) for the case when the RP accept political donations from national SIGs as

follows:(12)

τ iD (τ i* , α ) = −(pi (φi + π i )pi* (φi + π i )=,ε iM (1 − φi − π i ) ε iM * (φi − φi π i (1 − φi ))where π i = ϕφi dτ i dτ i
*

*

)

R*

> 0 , and π i < 1 − φi . 10

( )(From the comparison of Equation (12) with (5), we see 0 < τ iN τ i* < τ iD τ i* , α8) when thecountry is an importer of good i and levies a positive import tariff on it ( ε iM < 0 ), whileτ iD (τ i* , α ) < τ iN (τ i* ) < 0 when the country is an exporter of good i and imposes a positive export
tariff on it ( ε iM > 0 ), at any τ i* and α .

This shows that the RP enhances trade barriers whenit accepts political contributions from national SIGs, since in this case the RP has the politicalsupport motive in addition to terms-of-trade motive for trade intervention.
same as those in Grossman and Helpman (1995a).

These results are the

The rational behind the political support

motive is that the welfare of the country increases when the other country decreases its tradebarriers ( Wτ * < 0 in the case that the country is the exporter of good i, and Wτ * > 0 in the caseiithat the country is its importer), and national SIGs can make the RP in the other country
decrease its trade barriers by demanding that the domestic RP increase its trade barriers(( dτ i dτ i
*

)

R*

> 0 ) by means of political donations. 11

We also see from Equation (12) themonotonous relationship between τ iD and α : ∂τ iD ∂α > 0 when the country levies a positive
import tariff on good i ( ε iM < 0 ), while ∂τ iD ∂α < 0 when the country imposes a positive export
tariff on it ( ε iM > 0 ).
barriers increase.

This shows that when the RP highly values domestic donations, its trade

These discussions are summarized in the following proposition.

Proposition 1 (Grossman and Helpman, 1995a). When a RP is permitted to accept
political donations from national SIGs, a RP increases its import/export tariffs from those in thecase of no donations, at any given tariffs of other country and at any given weight on domestic
donations. The more a RP evaluates domestic donations, the more the country’s tariffs increase,at any given tariffs of other country.

4. Multilateral LobbyingThis section considers the case of multilateral lobbying, in which each SIG is permitted
to give its donation across the border, and each RP accepts donations both from domestic andforeign SIGs. j-SIG chooses publicly observable bilateral contract offers CDj(τ ) to the home RP(τ (τ ),τ ) = C (τ ) to the foreign RP (cross-border lobbying).

(domestic lobbying) and C

C j

Similarly, j*-SIG chooses C

D* j *

*

*

C j

*

(τ ) to the foreign RP and C (τ ,τ (τ )) = C (τ ) to the home*

C * j*

9*

C * j*RP.

The RP’s objective function for the home (foreign) country in the case of multilaterallobbying is GM(τ ;τ ) ( G (τ ,τ ) ) (M to the upper right represents “multilateral lobbying”),
*

M*

*

which is composed of national welfare W ( W * ), domestic donations Σ j Ccross-border donations Σ j*C

C * j*( Σ jCC j

M*( Σ j* C

D* j *), and).

Policymakers’ objective functions in the home country, G
foreign country, GDjM(τ ;τ ) , and those in the*(τ ;τ ) , are the weighted sum of the local welfare after deducting the total*

amount of political contributions local SIGs donate and the total amount of donations local RP
accept, as follows:
K
K
⎛
⎞
C j
G M τ ;τ * ≡ (1 − α − β )⎜⎜W τ ,τ * − ∑ C Dj (τ ) − ∑ C τ * ⎟⎟
j =1
j =1
⎝
⎠

(

(13a)

)

(

)

( )

K

K*

j =1

j *=1

+ α ∑ C Dj (τ ) + β ∑ C C* j* (τ ) ,
K*
K*
⎛
⎞
G M * τ * ;τ ≡ 1 − α * − β * ⎜⎜W * τ ,τ * − ∑ C D* j* τ * − ∑ C C* j* (τ )⎟⎟
j *=1
j *=1
⎝
⎠

(

(13b)

) (

)

(

)

( )

( )

K*

K

+ α * ∑ C D* j * τ * + β * ∑ Cj *=1

where 0 < β < 1 , 0 < β < 1 , α ≤ 1 − β ≤ 2α , and
*

C j

(τ ),
*

j =1

α * ≤ 1 − β * ≤ 2α * .

These restrictions

assure that all the donations to the home RP ( C Dj and C C * j* ) and those to the foreign RP ( C D* j*
and C

C j

) have positive weights in GM(τ ;τ ) and G (τ ;τ ) . The RP of the home (foreign)
*

M*

*

country chooses τ i ( τ i* ) to maximize Equation (13a) (Equation (13b)), with τ i* ( τ i ) considered to
be given.
I solve this problem backwards, in the same way as the domestic lobbying case.

At thesecond stage, the home RP and the foreign RP decide τ i and τ i* , respectively, to maximize theirobjective functions.

Differentiation of Equation (13a) with τ i and that of Equation (13b) with10

τ i* create the first-order conditions for maximization of objective functions for the home RP as
Equation (14a) and for the foreign RP as Equation (14b), respectively.
K

K*

j =1

j *=1

GτMi ≡ (1 − α − β )Wτ i − (1 − 2α − β )∑ CτDji + β ∑ CτCi * j* = 0 ,

(14a)

(

)

(

Gτ * ≡ 1 − α − β Wτ * − 1 − 2α − β

(14b)

M*
i

*

*

*
i

*

)∑ C
K*

*

j =1

K

D* j *

τ i*+ β ∑ Cτ * = 0 .
*

j =1

C j
i

Next, at the first stage, each SIG chooses its schedule of donations.

As in the previous

section, I focus on truthful equilibrium, where all lobbies make a positive contribution.

In otherwords, in equilibrium, the following equations are satisfied.

(τ ) = W (τ ,τ ) − W ,(15a)

C Dj (τ ) + C(15b)

C D* j* τ * + C C * j* (τ ) = W * j* τ ,τ * − W * j* .

C j

j

*

( )

j

*

(

)

These conditions are the same as the definition of weakly truthful transfers by Prat andRustichini (2003).

Each SIG decides its contribution schedules to both home and foreign RPs

under the constraint of Equation (15a) or (15b).

That is, in a truthful equilibrium of contract

offers, the following conditions are satisfied for SIGs.

Cτ i + Cτ *

(16a)

Dj

C j
i

*
dτ i*
j
j dτ i= Wτ i + Wτ *,i
dτ i R*dτ i R*CτD* * j* + CτCi * j*

(16a)

i

CτDji

dτ i
dτ
C j
+ Cτ * = Wτ ij *i + Wτ *j ,*iidτ i Rdτ i R**dτ i
D * j * dτ i
C * j** j * dτ i* j*
* j * dτ i
=
W
+
W
,
C
+
C
=
W
+ Wτ*i j* .
*
*
*
τi
τi
*
*
τi
τi
τi
τ
τ
d
d
dτ i Rdτ i R
i R*
i R*

Solving Equations (16a) and (16b) respectively produces the following equations.
(17a)CτDji = Wτ ij , Cτ * = Wτ *j ,C jiCτDi * j* = Wτ*i j* , CτC** j* = Wτ *j* .

(17b)

i

i

i

That is, when SIGs design their donation schedules to home and foreign RPs, all they need to take
into consideration is the direct effect of home and foreign tariffs on their welfare.

Strategic

relationships between countries have no role to play in the case of multilateral lobbying, becausesuch an indirect effect is properly replaced by a direct effect.

In the absence of contributions

from home SIGs to the foreign RP, any rise in the home export/import tariffs leads to a fall in theforeign import/export tariffs, which strategic effect home SIGs take into consideration when theydecide their donations schedules.
efficient.

This indirect way to change the foreign tariff is, however, not

By contributing to the foreign RP directly, this strategic effect is eliminated inequilibrium so that only the direct effect remains, which promotes efficiency of policy formation in
the home country.

This is the first benefit of cross-border political donations.
11

The samearguments apply for the foreign country, and this result can be rewritten as the following
proposition.

Proposition 2. When both domestic and cross-border lobbying activities are permitted,
the schedules of donation presented by a SIG to a home RP and a foreign RP are determined by
the direct effect of home tariffs and foreign tariffs, respectively, on the SIG’s welfare.
Substitute Equations (17a) and (17b) into (14a) and (14b), then(18a)Wτ i + ωWτ*i = 0 ,Wτ** + ω *Wτ * = 0 ,

(18b)

i

where ω = β α and ω = β**i

α * . These equations show that, in the case of multilaterallobbying, the RP takes into account the impact of its trade policy on the welfare of the othercountry through cross-border donations, which makes the RP more cooperative with the othercountry.

This is the second benefit of cross-border political donations.

((18b) define reaction functions τ i τ i , ωM*Equations (18a) and) for the home country and τ (τ , ω ) for the foreign
M*
i

*

i

country, respectively, for the case in which the RP accepts political donations from both national
SIGs and the other country’s SIGs, which are written as follows:(19a)τ iM (τ i* , ω ) = (ω − 1)

(19b)

τ

M*
i

pi*φi*p= ω −1 M*+ ω *τ i = 1 − ω * Mi + ω *τ i .
*ε i 1 − φiεi(τ , ω ) (
*

i

piφi
pi*
*
(
)
+
ωτ
=
1
−
ω
+ ωτ i* ,iε iM (1 − φi )ε iM *

*

)

(

(

)

)

(

)

( ) when the

From the comparison of Equations (19a) with (5), we see τ iM τ i* , ω < τ iN τ i*home country is an importer of good i ( ε iM< 0 ), while τ iN (τ i* ) < τ iM (τ i* , ω ) when the country is anexporter of it ( ε iM > 0 ), at any τ i* and ω .

This shows that the RP reduces trade barriers in thecase of multilateral lobbying from those in the case of no donations as in Section 2, due to the two
benefits of cross-border lobbying mentioned above. To put it in a different way, the politicalsupport motive in this case has an opposite effect on import/export tariffs from that in the case ofdomestic lobbying. 12

We also see again from Equation (19a) the monotonous relationshipbetween τ iM and β : ∂τ iM ∂β < 0 when the country imports good i, while ∂τ iM ∂β > 0 when
the country exports it. This shows that when the RP highly values cross-border donations, itstrade barriers decreases.

In the case of multilateral lobbying, the strategic relationships

between tariffs in two countries disappear, and the RP only counts the direct effect of its trade
policy on the welfare of both countries.

The reduction of trade barriers (export and import
12

tariffs) in a country is beneficial for the other country, and the more highly the RP values political
donations from abroad, the more the RP lowers its trade barriers for the foreign country. From
Equations (19a) and (19b) I derived the third proposition.

Proposition 3. When a RP accepts both domestic and cross-border donations, a RP
decreases its import/export tariffs from those in the case of no donations, at any given tariffs ofother country and at any given weights on donations. The more highly a RP values cross-border
donations compared with domestic donations, the more the country’s tariffs decrease, at any given
tariffs of other country.
Comparing this case with the case of no donations, the shift of tariff reaction curves after
admitting only domestic lobbying is in the opposite direction from the shift of those after
admitting multilateral lobbying. This results from the differences between the SIG’s and RP’s
behavior in two cases. Consider the relationship between the donations schedules of SIGs andother country’s tariffs first.

In both cases, the home country’s welfare increases when the foreigncountry lessens its export/import tariffs.

In order to have the foreign RP decrease its tradebarriers, in the case of domestic donations, home SIGs request the home RP to increase its own
export/import tariffs by means of domestic donations, which leads the shift of reaction curves ofhome tariffs to the direction of enhancing trade barriers.

This is an indirect way of decreasing

the other country’s trade taxes, by employing the strategic relationships between trade policies.
In the case of multilateral lobbying, however, home SIGs can use a direct way; they directly
request the foreign RP to decrease its trade barriers by means of cross-border donations.
reaction curves of home tariffs, therefore, don’t change.

The

Second, as for RPs’ objective functions,RPs don’t consider the welfare of the other country in the case of domestic lobbying, and so thereaction curves of home tariffs don’t depend on it.

In the case of multilateral lobbying, however,

the home RP needs to take care of the other country’s welfare, because it receives cross-border
donations from foreign SIGs.

The reaction curves of home tariffs, therefore, shift to the directionof lowering trade barriers. 13

5. Efficient Policies
Multilateral lobbying moves the trade policy of two countries toward a Pareto-efficientpair of tariffs.
locus.

It doesn’t guarantee, however, that a new equilibrium locates on Pareto-efficiency

In this section, I examine closely the condition for multilateral lobbying to yield Pareto

efficiency and to maximize the weighted sum of two countries’ welfare.
A Pareto-efficiency locus is defined as the set of a pair of tariff vectors which satisfies thefollowing condition.
(20)

dτ i
dτ
= *i
.
*
dτ i dW =0 dτ i dW *=013(τ ,τ ) are the tariff vectors which satisfy Equation (20), and are called “efficient tariffs.”
PE

* PE

The pair of efficient tariffs is achieved under the condition ωω * = 1 , which is verified as follows:dW = 0 and dW * = 0 require the conditions, respectively,
dτ i
,
−
=
Wτ i
dτ i*
Wτ *

(21a)

(21b)

i

−

Wτ**
i

*

Wτ i

=

dτ i
.
dτ i*

Under the equilibrium of multilateral lobbying, both Equations (18a) and (18b) are satisfied, so if
we substitute Equation (18b) into Equation (21a) and Equation (18a) into Equation (21b), we findthat Equation (20) is satisfied for all goods when ωω * = 1 .
Equation (18b), and we obtain Wτ * + ωWτ** = 0 .
iNext, substitute ωω * = 1 into

This equation and Equation (18a) arei

considered to be the first-order conditions for maximization of the weighted sum of home andforeign welfare, where ω is a weight for foreign welfare. From these arguments, I obtain thenext proposition.

Proposition 4.

ωω * = 1 .

(τ ,τ ) attains equilibrium in the case of multilateral lobbying when
PE

* PE

(τ ,τ ) maximizes the weighted sum of home and foreign welfare, where ω is a
PE

* PE

weight for foreign welfare.
It is directly derived from Proposition 4 that the condition which maximizes theunweighted sum of home and foreign welfare, i.e., world welfare, is(ω , ω ) = (1,1) . This means*that when each RP values domestic and cross-border donations with the same weight ( α = β
and α = β ) potential benefit from multilateral lobbying is maximized.
**

The following is astraightforward corollary of Proposition 4.

Corollary. World welfare is maximized when each RP makes no distinction between
domestic and cross-border donations.
Solving Equations (19a) and (19b) with the condition(ω , ω ) = (1,1) yields the result*τ i − τ i* = 0 . This condition implies that two countries set the net trade barriers of good i at zeroso as not to distort trade flows, and then the local prices of good i are equal to each other. 14

6. Extension: International Trade with Negative Externality
The model developed in previous sections doesn’t deal with the external effect.
Externality does not, however, change the propositions mentioned above if welfare functions
14

preserve concavity.

This section illustrates this statement by introducing externality negative towelfare into the model, along the lines of Ederington (2001), Conconi (2003), and Limão (2005).
They studied trade and domestic policies in large open countries with the presence of negative
externalities arising from their production.

In this section I examine the determination ofpolicies with the existence of negative externality, first in the context that there are only trade
policies, and second in the context that there are both trade and domestic policies.
6.1. The case of one policy tool: tariff
I slightly modify the model setting presented in Section 2; the productions of
non-numeraire goods are assumed to be accompanied by international negative externalities as
by-products in both countries.
nonpecuniary manner.

This decreases the welfare of individuals in both countries in a(

I examine hereinafter the determination of τ i ,τ i*) in the cases of

no-lobbying and of cross-lobbying.
The utility function of individuals (Equation (1)) is modified to the following form:N(22)

u (c 0 , c1 ,..., c N , Z ) ≡ c 0 + ∑ u i (ci ) − Z ,i =1

where Z is total externalities to the country from the productions of non-numeraire goods.

The

degree of Z is a function of the outputs in both home and foreign countries as follows:
(23)

(

)

N

[

( (

))

( (

))]

Z τ ,τ * ≡ ∑ η id Yi pi τ i ,τ i* + η ic Yi* p i* τ i ,τ i* ,
i =1where η id ≥ 0 is the parameter of externality which represents the extent to which domestic
production of good i decreases the utility of individuals.

η ic ≥ 0 is the parameter of cross-border

externality from the production of good i in the other country.
Conconi (2003).

Equation (23) is the same as

If η ic = η ic* = 0 , then there is no cross-border externality concerning the

production of good i, which case Ederington (2001) considered.

Ifη ic = η id ≠ 0 andη ic* = η id* ≠ 0 , then the externalities from two countries are completely indifferent for the home
and the foreign, respectively. 15
Domestic welfare is redefined as the total amount of labor income, rent, tariff revenue,
consumer surplus, plus the negative effect of externalities.

15

(24)

H
N
N
⎡H
⎤
W τ ,τ * ≡ L + ∑ Ri (τ i ,τ i* ) + ∑ τ i M i (τ i ,τ i* ) + H ⎢∑ u i ci τ i ,τ i* − ∑ p i ci τ i ,τ i* ⎥
i =1
i =1
i =1
⎣ i =1
⎦

(

)

( (

(

))

(

)

)

− HZ τ ,τ * .
When the RP sets its tariff unilaterally to maximize its domestic welfare, taking thetariff of the other country as given, the resulting reaction function of tariff on good i is defined by
(25)

τi =

pi*

+
M*

εi

Hη id ε iY Hη ic ε iY *− * M* ,mi ε iMmi ε i()()

where ε iY ≡ (∂Yi ∂p i )( p i Yi ) > 0 , ε iY * ≡ ∂Yi * ∂p i* p i* Yi * > 0 , mi ≡ M i Yi , and mi* ≡ M i* Yi * .
Compared with Equation (5), Equation (25) has two additional terms: Hη id ε iY mi ε iM

Hη ic ε iY * mi*ε iM * .

andHη id ε iY mi ε iM represents the welfare effect of externalities from the local

production of good i, which varies according to the local price of good i.

Hη id ε iY mi ε iM < 0always holds, which means that the increase of τ i strengthens the negative externality on local
welfare through the increase of the local price of good i and, therefore, the production of it. 16

Hη ic ε iY * mi*ε iM * represents, on the other hand, the welfare effect of externalities from theforeign production of good i.

− Hη ic ε iY * mi*ε iM * > 0 always holds, which means that theincrease of τ i lessens the negative externality, through the decrease of the foreign price of good i,
which decreases in turn the foreign production of good i.

The reaction function of τ i ,determined from Equation (25), might be higher or lower than that from Equation (5), dependingon the relative strengths of these two terms.
In the case of multilateral lobbying with

(ω , ω ) = (1,1) , the reaction functions of tariffs*

on good i in the home and foreign countries are expressed as 17(Hη + H η )ε < 0 .
τ =
*

(26)

id

i

*
ic

Y
i

mi ε iM

Equation (26) shows that the level of τ i is determined by the effect of τ i on negative externality

16caused from the domestic production of good i to the welfare of the home country, Hη id ε iY mi ε iM ,and by the effect on externality to the welfare of the foreign country, H *η ic ε iY mi ε iM .

This

form represents the fact that optimal assignment for trade policy in a country, with the existenceof negative externality, exists to redress its own externality.
term representing optimal tariff.

Equation (26) doesn’t include the

The monopoly power of countries is eliminated completely inorder to maximize world welfare.
6.2. The case of two policy tools: tariff and production tax
The previous part considers tariffs of two countries as a single policy tool.

The

theoretical framework of this paper can apply to the more general situation where each country
has more than one policy tool.

I consider in this part the case where each country has two policy

tools: tariff (trade policy) and production tax (domestic policy).
The theoretical framework in the case of two policy tools is similar to that in the previous
part.

One critical difference is that there is a wedge between consumer and producer prices

because of the introduction of a vector of specific production taxes t = (t1 ,..., t N ) .

The producer

price of good i is thus equal to pis = piw + τ i − t i , while the consumer price is pic = piw + τ i .
The output of good i is redefined as Yi ( p is ) = ∂Ri ∂p is , the total externalities to the country Z) ∑ [η Y ( p (τ , t ,τ , t )) + η Y ( p (τ , t ,τ , t ))] , net import(is expressed as Z τ , t ,τ * , t * ≡

N

i =1

id

i

is

i

i

*
i

*
i

*

ic i

*
is

i

i

*
i

*
i

demand is M i ( pic , pis ) = Di ( p ic ) − Yi ( pis ) , and the world equilibrium price which satisfies the()

market-clearing condition is given by p iw τ i , t i ,τ i* , t i* .
Domestic welfare is then rewritten in the same form as Conconi (2003).
(27)

(

)

W τ , t ,τ * , t * ≡ L + ∑ Ri (τ i , t i ,τ i* , t i* ) + ∑τ i M i (τ i , t i ,τ i* , t i* ) + ∑ t i Yi (τ i , t i ,τ i* , t i* )
N

N

N

i =1

i =1

i =1

H
⎡H
⎤
+ H ⎢∑ u i ci τ i , t i ,τ i* , t i* − ∑ pic ci τ i , t i ,τ i* , t i* ⎥ − HZ τ , t ,τ * , t * .
i =1⎣ i =1
⎦

( (

))

(

)

(

)

Objective functions of RPs and donation schedules of SIGs are extended so as to incorporate t
and t * in the same manner as τ and τ * . 18
17

When the RP sets its tariff and production tax unilaterally to maximize its domestic
welfare, taking the tariff of the other country as given, the resulting reaction functions of tariff() (and production tax on good i are defined by, respectively, τ i = p i* ε iM * − Hη ic ε iY * mi*ε iM *) andt i = Hη id . In this case, τ i is determined from the terms of trade effect: p i* ε iM * is the direct
welfare effect of the change of the terms of trade by τ i , while− Hη ic ε iY * mi*ε iM * is the indirect

welfare effect through the change of negative externality from the production of the other country,
which is caused by the change of the terms of trade.

t i is, on the other hand, set from the levelof negative externality from the home production: t i = Hη id is a nondistortionary production tax
to counter the local direct externality.

Note that t i is independent of τ i , τ i , and t i , while τ i**and τ i* are interdependent.
In the case of multilateral lobbying, the schedule of donations from j-SIG in the homecountry is slightly rewritten from Equation (15a) to C Dj (τ , t ) + C

C j(τ , t ) = W (τ , t ,τ , t ) − W .
*In a truthful equilibrium of contract offers, the conditions C ti = Wti
Djsatisfied, in addition to Equation (17a), for j-SIG.
andproduction

( (

taxes

are

)

)

derived

as

When

j

*

*

C j

j

and Ct *i*j= Wt *j arei(ω , ω ) = (1,1) , the equilibrium tariffs

τ i − τ i* = 0*and(ε (t − Hη − H η ) m )
Y
i

*

i

id

*
ic

i

− ε iY * t i* − Hη ic − H *η id* mi* = 0 , respectively. The former condition is the same as that in
Section 6, while the latter condition requires marginal production tax revenue of the world to beequal to marginal welfare loss of the world from negative externalities of productions.

7. Concluding Remarks
This paper examines the effects of lobbying activities across borders on determining
trade policies in a multi-principal, multi-agent, and menu-auction model.

The main result isthat multilateral lobbying, i.e., the situation in which both domestic and cross-border lobbying
activities are permitted, brings the equilibrium of tariffs in countries towards thePareto-efficiency locus, on the assumption that all the individuals belong to one of the domestic
SIGs.

When each RP evaluates political contributions from national SIGs and from abroad with18

the same weight, a Pareto-efficiency is attained at which the unweighted sum of the twocountries’ welfare is maximized.

In other words, in order to maximize world welfare, eachgovernment should allow every party the right to raise political funds from abroad, and eachparty should treat all the contributions equally, regardless of the nation of origin.
This result reestablishes the theoretical findings of Becker (1983) and Grossman andHelpman (1994) about the relationship of lobbying and efficient policies.

Becker (1983)

presented the proposition that competition among pressure groups favors efficient methods ofdomestic taxation in a country, and Grossman and Helpman (1994) stated that in a small
economy free trade prevails when all voters belong to one of the interest groups. My analysis
extends these statements, and proposes that efficient policies are successfully adopted and world
welfare is maximized even in the case of large countries, if all voters participate in thecompetition of lobbying by means of truthful multilateral donations in both the local and foreign
political arenas, and RPs treat domestic and cross-border donations equally. This would notassure, however, that the new equilibrium of the Pareto-efficient tariffs is Pareto-improving for
all countries.

To convert efficiently the potential benefit of multilateral lobbying into an actual

benefit for each country, an effective and powerful international scheme for regulating tariffs orincome transfer is required.
Readers may doubt some of the assumptions in the model, especially those aboutprincipals (SIGs), agents (RPs), and an outcome (truthful equilibrium) of a menu-auction.

First,

as for SIGs, an extreme assumption is that every individual can express his or her preference toboth home and foreign RPs through the SIG to which it belongs.

Reflecting on the behavior of

actual SIGs, it is natural to consider the existence of some political costs of forming andmaintaining SIGs, which result in some individuals choosing not to participate in lobbying
activities.

Mitra (1999) introduces this political cost and analyzes endogenous lobby formation.

My assumption corresponds to Mitra’s model when every individual participates in a SIG andcosts of lobbying are sufficiently low.

I have to admit, however, that collecting information on thetax policies of all countries and making out their schedules of donation could be laborious work for
all SIGs.

Second, as for RPs, the total amount of donations each RP collects becomes excessively

large when all SIGs follow truthful transfers, since each RP has a monopolistic power in thelegislative branch of government.
unacceptable to citizens.

This kind of fund-collecting behavior by political parties is

And third, the practicability of truthful transfers might be suspect.

Kirchsteiger and Prat (2001) run an experiment and find that the truthful alternative is chosen in
only a fraction of all matches. This undermines our discussion, since truthful equilibrium is a
crucial characteristic of all the propositions presented in the text.
Despite these caveats, the main message of this analysis still holds. That is, foreign
political contributions per se are not harmful in the world. Rather, they help every government
to be aware of foreign concern for its economic policy, and to become more sensitive to the impact
of its policy on world welfare. Binding contracts of cross-border political contributions withoverseas RPs are efficient tools by which SIGs can reveal their interests in the economic policies
19

of foreign countries.

In this sense, free international lobbying serves well as a catalyst for

creating a more cooperative and efficient world economy. Some may think that cross-border
donationsbecomeself-determination.

threats

againstnations,

sovereignty

and

their

right

to

political

With the rise of multinational corporations and the increase in foreign tradeand investment, foreign people seek to influence the domestic policies of the nations in which they
do business.

This growing foreign political influence has caused elected officials of many

countries to fear that their nations’ political and economic independence is at risk. Seen from adifferent point of view, these domestic concerns are an indication that governments need to take
into account the impact of their legislation on the welfare of other countries.

Based on the modelin this paper, such awareness can be considered an important component in future meaningfulinternational cooperation.

20

Table 1: Number of countries which ban foreign donations:by income and region
Is there a full ban on foreign donations to political parties?
Yes

No

40

71

100,000 plus

14

15

10,000 - 99,999

13

13

1,000 - 9,999

1125

up to 9992

18

10,000 plus

11

173,000 - 9,999

10

191,000 - 2,999

10

15

up to 999

920

Africa4

19

The Americas

12

20

Asia

6

4

Europe17

17

Oceania1

11

Total:GDP (million US$, 2003):

Per capita GDP (US$, 2003):

Region:Source: Austin and Tjernström (2003), World Bank (2004)21

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23

Appendix: First-Order Conditions in Section 6.2.
First-order conditions for maximizing Equation (27) with respect to τ i , t i , τ i* , and t i*are, respectively,
(A.1)

⎛ ∂D
∂Y ⎞
∂Yi
(1 − φi )Wτ i ≡ M iφi + τ i ⎜⎜ i − i ⎟⎟(1 − φi ) + t i
∂
∂
p
p
p
∂
is
is ⎠
⎝ ic
*
⎤
⎡ ∂Yi
(1 − φi ) − η c ∂Yi* φi ⎥ = 0 ,− H ⎢η d∂pis ⎦⎣ ∂pis

(A.2)

⎛ ∂D
⎞
∂Y
∂Yi
(δ i − 1)Wti ≡ − M i δ i + τ i ⎜⎜ i δ i − i (δ i − 1)⎟⎟ + t i
∂pis
∂pis
⎝ ∂pic⎠*⎤⎡ ∂Yi(1 − δ i ) − η c ∂Yi* δ i ⎥ = 0 ,+ H ⎢η d∂pis ⎦⎣ ∂pis(A.3)⎤⎡ ∂Yi *
⎛ ∂D
∂Y ⎞
∂Y
∂Y *
φi − η c i* (1 − φi )⎥ = 0 ,Wτ * ≡ M iφi* − τ i ⎜⎜ i − i ⎟⎟φi* − t i i φi* + H ⎢η d
i
∂pis
∂pis
⎝ ∂pic ∂pis ⎠⎦⎣ ∂pis(A.4)⎡ ∂Yi *⎛ ∂Di ∂Yi ⎞ *
∂Yi *
∂Yi*
* ⎤
⎜
⎟
−
H
+
t
δ
δ
η
δ
η
1
δ
−
−
−
Wt * ≡ − M i δ + τ i ⎜⎥ = 0,
⎢
i
i
i
i
i
c
d
⎟
i
∂pis
∂pis*
⎝ ∂pic ∂pis ⎠⎦⎣ ∂pis(*iwhere δ i = ∂piw ∂t i , δ i* = ∂p iw ∂t i* , 0 < δ i < 1 , and 0 < δ i* < 1 .

(and production tax on good i, τ i = p i ε i*M*) − (Hη ε
ic

Y*
i

)

Reaction functions of tariff

mi*ε iM * ) and t i = Hη id , are acquired

from Equations (A.1), (A.2), and the market-clearing condition, assuming φ i ≠ δ i .
When(ω , ω ) = (1,1) , the equilibrium tariffs and production taxes which maximize world*

welfare satisfy the following conditions.
(A.5)

Wτ i + Wτ*i = 0 ,(A.6)

Wti + Wti* = 0 ,(A.7)

Wτ * + Wτ** = 0 ,
i

i

24

(A.8)

Wt * + Wt** = 0 .
iiOne way of calculating the equilibrium tariffs and production taxes is as follows: from Equations(A.5) and (A.7), Wτ i + Wτ i + Wτ * + Wτ** = 0 , assuming φ i + φ i* ≠ 1 .
*i

and (A.8), Wti + Wti + Wt * + Wt ** = 0 , assuming δ i + δ i* ≠ 1 .
*i

From these two equations, wei( (acquire τ i − τ i = 0 and ε i t i − Hη id − H η ic*

Also, from Equations (A.6)

i

Y

*

*

) m ) − (ε (t − Hη − H η ) m ) = 0 .
i

25

Y*
i

*
i

*

ic

*
id

*
i

1 The positive and negative opinions for political donation from abroad in the context of the U.K.

are well summarized in the report of the Committee on Standards in Public Life (Committee onStandards in Public Life, the U.K., 1998), presented to the Parliament in 1998 as backgroundmaterial to discuss the regulations of political funding.

In this document, the arguments against

the imposition of a ban on foreign donations are categorized into six points as follows (Volume 1,
pp. 65-68).

(1) There are a number of political parties within the U.K. which rely on and value

contributions from those living overseas.

(2) There is nothing intrinsically wrong with anoverseas donation, provided that it does not come from a foreign government.
foreign donations has been exaggerated.

(3) The impact of(4) It is difficult to stipulate a satisfactory definition of

the persons and corporations which must be treated as foreign, for the purpose of a legislative ban
on foreign donations.

(5) Concerning the upsurge of requirements for transparency anddisclosure of political funding, this is not the time to introduce a further legislative restriction on
the ability of political parties to secure adequate funding.

(6) Two special cases: the treatment ofsome territories which come under the sovereignty of the U.K. and of future cross-border parties
in Europe. This document presents, as well, the arguments in favor of a ban including thefollowing four points: (1) Since political parties are involved in the domestic process taking place
within the U.K., political parties should be confined to seeking financial support from thoseentitled to vote for them.

(2) Disclosure is not enough.

(3) Such difficulties as there may bewith the legislative definition of a ban must be tackled, and the best solution possible produced.
(4) Allowing donations from dependent territories would potentially open up a substantial
loophole in the prohibition of foreign donations.
2 The first U.S. law banning foreign contributions to political campaigns was enacted in 1966.

The amended Foreign Agents Registration Act (FARA) declared it a felony for a foreign principal
to use an agent to contribute to domestic election campaigns or for a candidate to accept or solicit
such contributions. The language of this prohibition, however, still permitted foreign nationals toprovide funds directly to candidates.

After this loophole was widely recognized through theWatergate hearings, Congress revised the Federal Election Campaign Act to prohibit
contributions from any foreign national in 1974.

Despite this revision, foreign money can still

enter U.S. campaign treasuries through U.S. subsidiaries of foreign corporations. In general,
U.S. law prohibits direct contributions from corporations to federal political campaigns, but U.S.
corporations may establish political action committees (PACs), which have the right to makelimited campaign contributions.

Thus, a U.S.-incorporated, foreign-owned company’s PACs

could serve as a conduit for foreign funds to U.S. electoral campaigns, provided that they are
registered with the Justice Department in accordance with the FARA (Damrosch, 1989; Powell,1996).

The definition of “foreign agent” in Gawande, Krishna, and Robbins (2004) and Kee,

Olarreaga, and Silva (2004) refers to this type of PAC. Note that both papers use the grossamount of money for agents’ activities in the U.S. as a variable for the extent of their presence inthe U.S. political arena.

In contrast, the amount of political donations to politicians has a key

26

role in my research.
3

The home and the foreign countries have similar economic structures, so I don’t refer toconditions for the foreign country explicitly in Sections 2, 3, and 6 in the text.
4 When the country is a net importer of good i,

τ i > 0 and τ i < 0 mean an import tax and an

import subsidy, respectively. When the country is a net exporter of good i, τ i > 0 and τ i < 0denote an export subsidy and an export tax, respectively.
5This model setting doesn’t deal with the external effect.

Externality does not change theresults of this paper if welfare functions preserve concavity concerning τ and τ .
*See Section

6, for an example.
6

G N is the function of τ , with τ * as given; the RP of the home country uses τ as a policy

instrument, but it cannot manipulate a foreign country’s policy instrument τ*

directly.

7 In the case of a small country, this assumption brings the result that free trade prevails in all

sectors, as shown in Grossman and Helpman (1994), because the various SIGs neutralize one
another. In the setting of this model, however, the results turn out to be different.
8 I focus on equilibrium where all SIGs make a positive amount of political contributions to theRP.
9 It is assumed that the rise in the tariff on good i (τ i ) increases its local price ( pi ) even though it

also leads to the rise in the other country’s tariff ( τ i ), which in turn decreases the home country’s*

price of good i ( pi ).

It is expressed as()(

0 < (∂pi ∂τ i ) + ∂pi ∂τ i* dτ i* dτ i

)

R*

, or

φi* (dτ i* dτ i ) R* < 1 − φ i .
10The

condition

π i < 1 − φi

comes

from

the

condition

mentionedinfootnote8:

π i ≤ φi* (dτ i* dτ i ) R* < 1 − φ i , since 0 < ϕ ≤ 1 .
11 From Equation (11), when

α = 1 in the home country and α * ≤ 1 2 in the foreign country (inthe case in which a foreign RP doesn’t receive domestic donations), the intersection point ofreaction functions τ iD(τ ,α ) and τ (τ ,α ) satisfies the condition − (W W ) = (dτ dτ ) .
*
i

D*
i

*

τi

i

τ i*

*
i

i

R*

This is a Stackleberg equilibrium in which the home country is the leader and foreign country is
the follower.

This implies that when the foreign country doesn’t permit domestic lobbying

activities, the home country is always better off permitting domestic lobbying and moving

27equilibrium toward a Stackleberg equilibrium.

Under the restriction of 1 2 < α ≤ 1 and

1 2 < α * ≤ 1 , however, a new equilibrium in the case of existing domestic lobbying in bothcountries is the point where at least one country must be worse off.
12 This result is stronger than the statement in footnote 10 in Grossman and Helpman (1995a),where they indicated that, at any given tariff of other country, a tariff in the case in which both
domestic and cross-border donations are permitted is lower than that in the case in which only
domestic donation is permitted.

Proposition 3 means that a tariff in the former case is evenlower than that in the case of no donations.
13 The model of multilateral lobbying presented in the text has enough applicability for the case ofinternational SIGs.

The role of international SIGs, organized by some SIGs in different

countries, on the determination of trade policies was originally examined by Conconi (2003).

Inthe context of my model, when some home and foreign SIGs form an international coalition andaim at maximizing an unweighted sum of their welfare by giving political contributions to boththe home and foreign countries, the international SIG designs its donation to home and foreign
RPs considering only the direct effect of home and foreign tariffs on its aggregate welfare,respectively.

Again, strategic relationships between trade policies of the two countries disappear.

Therefore, incorporating international SIGs into my model does not change the main argument in
the text.
14 The condition

τ i − τ i* = 0 does not guarantee, however, that both home and foreign countries(

increase their local welfare before donating political contribution, W τ ,τ*) and W (τ ,τ ), by**

multilateral lobbying, even when τ i = τ i = 0 . One implication of this theoretical fact is that, in*order to extract the full potential benefit from multilateral lobbying and ensure that each country
increases its pre-donating local welfare, it is necessary not only to have each RP value domestic
and cross-border donations with the same weight but also to establish some sort of international
institution which handles negotiations about Pareto-improving tariffs or international transfer.
Though mechanism design of tariffs or income redistribution Pareto-improving for allparticipants is an important problem, it is outside of the scope of this paper.
15 It is possible for total externalities to have a more general form concerning the output of goods,

as long as strong concavity of utility functions is preserved.

If the reader interprets negative

externalities as environmental pollution, it might be natural to consider that total externalities
are the function of accumulated pollutants produced from past economic activities.

The

accumulation of externalities, however, is beyond this comparative static analysis.
16 When the country is an importer of good 1, this term means that the country has an incentive to28

decrease its import tariff so as to decrease the domestic price of good 1 and then reduce its
domestic production. When the country is an exporter of good 1, on the other hand, this termshows the incentive to elevate its export tariff.
17 It is assumed thatφi + φi* ≠ 1 in order to avoid the indetermination of equilibrium tariffs.

18 The derivation of first-order conditions in this part can be found in the Appendix.

29