TRADE ADJUSTMENT, POLITICAL PRESSURE, AND TRADE PROTECTION PATTERNS

I. INTRODUCTION Even the most passionate supporters of free trade would admit that trade liberalization is frequently accompanied by considerable costs in terms of unemployment and relocation of workers who have lost their jobs due to intensified import competition. Laid-off workers must be compensated during their job search and, often, they must be retrained in order to acquire the skills needed to enter a new industry. While economists generally agree that the gains from trade eventually outweigh the costs of adjustment, we also recognize that recovery may take years. Years, that an incumbent politician who faces re-election and has to bear the direct costs and indirect consequences of adjustment does not have. In this article, I extend the seminal work of Grossman and Helpman (1994) (G-H hereafter) to show that, even though they are not large budgetary expenses, trade adjustment considerations are important determinants of trade policy. The most interesting and important finding is that trade-induced unemployment and trade-adjustment costs can generate positive levels of trade protection for unorganized industries, even in the presence of political pressure from the organized sectors. This prominent feature of the data cannot be explained by the G-H model and, therefore, cannot be captured by empirical studies that apply the G-H framework in its original version. To perform the empirical analysis, I use novel U.S. data sets that directly identify trade-induced unemployment and enable measurement of trade-related retraining costs. The latter allow me to introduce adjustment costs into the extensive empirical literature on endogenous trade protection, which, to the best of my knowledge, has yet to quantify the importance of adjustment considerations as motives for protection. The highly visible political fallout related to trade-induced unemployment and trade adjustment costs make them very appealing arguments for proponents of trade protection, especially in a political economy setting where the public official cares about re-election. Vocal media coverage of plant closings, lost jobs, and growing income inequality, all blamed on trade, and stories of the hardships faced by workers who have lost their jobs because of increased imports, are issues dear to the heart of a patriotic voter. (1) Given the populist view that trade destroys domestic jobs, and the altruistic nature of voters, who are willing to pay higher prices for imported goods in order to save domestic jobs, it is not hard to see how the political costs from lost jobs could be substantially larger than the actual expenditures needed to help the displaced workers. In other words, the political benefits from helping trade-affected workers and saving domestic jobs may outweigh the monetary costs of doing so within the context of a political agenda aimed at garnering votes. Accordingly, I find that the government in office is highly sensitive to the presence of trade-induced unemployment and trade-adjustment costs, despite their small monetary value. Furthermore, I argue that a static setting, where the same analysis could be repeatedly applied for each election cycle within a dynamic model, is very appropriate to capture the political motives that I describe here. Following Grossman and Helpman (1994), I derive the optimal level of sectoral trade protection as a locally truthful, sub-game Nash equilibrium in a static model, where, in addition to responding to political pressure from organized industries, the incumbent official is sensitive to the presence of trade-induced unemployment and trade-adjustment costs. The story behind the model is straightforward. Due to wage rigidity, a fall in world prices results in unemployment and, consequently, in redistribution of skilled workers. Under the existing Unemployment Insurance (UI) and Trade Adjustment Assistance (2) (TAA) programs, the government must pay unemployment benefits and must cover the costs of relocation and retraining of workers who have lost their jobs due to increased imports. …