metadata: authors: 0: author: Silva,Peri
count: Latin America
docna: 0: docna: The role of importers and exporters in the
            determination of the U.S. tariff preferenes granted to Latin America
docty: Policy Research Working Paper
subtopic: Political Economy,Social Analysis,Quality of Life & Leisure,National Governance,Government Policies,Pharmaceuticals Industry,Disability,Trade Policy,Pharmaceuticals & Pharmacoeconomics,Services & Transfers to Poor,International Trade and Trade Rules,Rules of Origin,Youth and Governance,Economic Assistance,Access of Poor to Social Services,Trade and Multilateral Issues
teratopic: International Economics and Trade
abstracts: cdata!: This paper investigates the role played
            by domestic importers and foreign exporters in improving
            preferential access to the domestic market. To this end, the
            framework used in this paper extends the protection for sale
            analysis to explicitly model the role of domestic importers
            and foreign exporters in the determination of preferential
            trade treatment. The predictions of the model are tested
            using data on preferential trade between the United States
            and Latin American countries. The results suggest that Latin
            American exporters and U.S. importers' lobbying efforts
            have a significant and important role in determining the
            extent of preferential access granted by the United States.
            More interestingly, these findings also show that U.S.
            importers capture a very substantial share of the rents
            generated by tariff preferences. These results therefore
            shed a pessimistic view on preferential trade schemes as a
            reliable source of gains for developing countries.
repnme: repnme: The role of importers and exporters in the
            determination of the U.S. tariff preferenes granted to Latin America
display_title: The role of importers and exporters
            in the determination of the U.S. tariff preferenes granted
            to Latin America
listing_relative_url: /research/2005/02/5642278/role-importers-exporters-determination-tariff-preferenes-granted-latin-america
topicv3: Political Economy of Trade and Investment
            m1326247 1180,Political Economy of Reform m1326263 836,Trade m1326924 698,Social Assistance m1327201 1466,Pharmaceuticals m1327740 1350
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: International Economics and Trade
no_of_pages: 50
author_keys: 0: author_key: 643712
model_extractions: # The Role of Importers and Exporters in the Determination of the U.S. Preferences Granted to Latin America<sup>∗</sup>

# Peri Silva<sup>†</sup>

## Abstract

This paper investigates the role played by domestic importers and foreign exporters in improving preferential access to the domestic market. To this end, the framework used in this paper extends the protection for sale analysis to explicitly model the role of domestic importers and foreign exporters in the determination of preferential trade treatment. The predictions of the model are tested using data on preferential trade between the United States and Latin American countries. The results suggest that Latin American exporters and U.S. importers’ lobbying efforts have a signi fi cant and important role in determining the extent of preferential access granted by the United States. More interestingly, these fi ndings also show that U.S. importers capture a very substantial share of the rents generated by tariff preferences. These results therefore shed a pessimistic view on preferential trade schemes as a reliable source of gains for developing countries.

JEL classi fi cation numbers: F10, F11, F13 Keywords: Trade, Political Economy, Latin America, United States.

World Bank Policy Research Working Paper 3518, February 2005 .

The Policy Research Working Paper Series disseminates the fi ndings of work in progress to encourage the exchange of ideas about development issues. An objective of the series

> ∗I am grateful to Giovanni Facchini, Earl L. Grinols, Marcelo Olarreaga, Werner Baer, George Deltas, Hadi Esfahani, and Mathias Polborn for helpful comments. Special thanks are due to Marcelo Olarreaga and Kishore Gawande for providing key parts of the data. Financial Support provided by the World Bank and the Hewlett Foundation is gratefully acknowledged as well.

> †Department of Economics, University of Illinois at Urbana-Champaign, Champaign, Illinois; Tel. (217)333-0120; Fax: (217)244-6678; e-mail: pasilva@uiuc.edu
is to get the fi ndings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The fi ndings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org.

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# Non-Technical Summary

This paper investigates the extent to which lobbying by foreign exporters and domestic importers (retailers and wholesale fi rms) determines the tariff preferences granted by an importing country. The predictions of the model are tested using data on preferential trade between the U.S. and Latin America. This empirical example is important since Latin American countries display a signi fi cant dependency on exports to the U.S. Moreover, about half of Latin American exports enter the U.S. market through a myriad of preferential schemes (Andean Act, Caribbean Basin Initiative, GSP, NAFTA, etc.) The empirical results suggest that lobbying by U.S. importers and Latin American exporters is an important determinant of the tariff preferences granted by the U.S. to that region. More interestingly, the empirical results indicate that U.S. importers capture a substantial share of the rents generated by tariff preferences. These fi ndings imply that importers are likely to be the engine behind the growth of tariff preferences. Moreover, they also shed a pessimistic view of preferential schemes as a reliable source of gains to developing countries.

1
# 1 Introduction

This paper develops a framework to investigate the importance of foreign exporters and domestic importers’ lobbying efforts in determining the tariff preferences granted by an importing country. Jobst (2002) argues that coalitions among domestic and foreign interests are capable of decreasing political opposition to trade liberalization since the pooling of resources from interested parties reduces the costs of lobbying to each member. However, there is no formal analysis that investigates whether joint lobbying by domestic importers and foreign exporters can enhance the market access of a group of exporting countries. To the best of my knowledge, this paper is the fi rst to provide an analysis of this subject.

There is substantial evidence that lobbying by domestic importers and foreign exporters plays an important role in the determination of tariff preferences. In particular, the trade relations between the U.S. and Latin America have consistently been shaped by pressure groups. In 2001, the National Retailers’ Federation (NRF)–a pressure group representing the interests of U.S. importers–lobbied vigorously against the application of tougher rules of origin on apparel products originating in countries which were members of the Caribbean Basin Initiative (CBI).<sup>1</sup> Jobst (2002) reports that the National Supermarket Association, in conjunction with the Colombian Association of Flower Exporters, lobbied successfully to prevent trade regulations that would have placed restrictions on exports of Colombian fl owers to the U.S. in the late 1980s.<sup>2</sup> Similarly, the Association of American Chambers of Commerce in Latin America, in partnership with the U.S.-Chile Free Trade Coalition, led the effort to secure Congressional Approval, effective in January 2004, of the U.S.-Chile Free Trade Area.<sup>3</sup>

> 1The NRF claimed that U.S. retailers are the major buyers of apparel produced in the the Caribbean Basin region, and if retailers do not have the proper incentives to provide apparel under the CBI, then all other U.S. industries down the supply chain will not be able to sell their products under the CBI. See the NRF website (www.nrf.com) for more information.

> 2See Jobst (2002), pp. 10

> 3The AACCLA is composed of 23 non-pro fi t, independent, business organizations based in 21 Latin American countries. Its primary objective is to promote trade and investment between Latin America and the U.S. See the AACCLA website (www.aaccla.org) for more information.

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To analyze the role played by pressure groups in the determination of tariff preferences, we consider a model in which an importing country, a group of preferential partner nations, and the rest of the world interact. Foreign-produced goods can be sold in the importing country if purchased by domestic agents named importers. We follow Maggi and RodriguezClare (2000) by assuming that importers are agents that supply the sector-speci fi c factor to conduct trade, without further costs. Their sole activity therefore is to purchase goods from a group of preferential partner countries to be sold to the importing country. The presence of importers in the model raises the question of how the rents generated by the tariff preferences are divided between foreign exporters and domestic importers.

In order to incorporate the presence of domestic importers, domestic producers, and foreign exporters, we use a two-stage political economy game. Tariff preferences granted by the importing country to preferential partner countries, and measured as the reduction of the tariff from the Most-Favored-Nation (MFN) rate, are determined in the fi rst stage using the common-agency framework developed by Bernheim and Whinston (1986) and Grossman and Helpman (1994). In the second stage, domestic importers decide how to divide the rents arising from the tariff preferences granted by the domestic government to imports from preferential partner countries. Thus, our model assumes that domestic importers enjoy a substantial degree of market power when facing foreign exporters. Since the rents arising from the trade preferences received by domestic importers and foreign exporters have an impact on their welfare and, consequently, affect their contribution schedules, the game is solved by applying backward induction.

Our analysis shows that importers and exporters tend to lobby for preferential access, rather than for changes in the MFN tariffs. The model also predicts that equilibrium tariff preferences depend on whether the elasticity of export supply is greater or less than the inverse of the tariff preference. If the sectoral elasticity of export supply for a particular country is lower than the inverse of its predicted tariff preference, then the preferential tariff is either zero or equal to the MFN tariff. In other words, a corner solution occurs, and this explains the stylized fact noticed by Kee, Olarreaga and Silva (2003) that most preferences 3
at the tariff line (Harmonized System 8 digits) are either zero or equal to the MFN tariffs.<sup>4</sup> We test the predictions of our model using data on preferential trade between the U.S. and Latin America. The empirical example investigated in this work is important since the U.S. is one of the wealthiest and largest economies in the world, and Latin America<sup>5</sup> constitutes a group of developing countries whose dependency on exports to the U.S. is signi fi cant.<sup>6</sup> Moreover, about half of Latin American exports enter the U.S. market through a myriad of preferential schemes.<sup>7</sup> The predictions of the model fi nd strong support in the data. Domestic importers and Latin American exporters’ lobbying activities signi fi cantly increase on average the U.S. tariff preferences granted to Latin American countries. Furthermore, the empirical exercise shows that U.S. importers (tend to) capture most of the rents generated by the tariff preferences granted to Latin American countries. These results offer a pessimistic view about using preferential trade schemes as a reliable source of gains for developing countries. These conclusions are robust to modi fi cations in the de fi nition of political organization, to the exclusion of agricultural goods, and to changes in the level of aggregation of the data.

The political economy of trade literature has been trying to evaluate the impact of foreign lobbying on U.S. trade policy. The relation between foreign lobbying and the determination of the U.S. MFN tariffs was investigated by Gawande, Krishna and Robbins (2004) using a Cournot-Nash competition model. They found that foreign lobbying decreases on average the MFN tariff applied by the U.S.. Kee, Olarreaga and Silva (2003) studied whether lobbying by Latin American exporters plays a signi fi cant role in the determination of the U.S. tariff preferences granted to that region. They concluded that Latin American exporters’ lobbying has a signi fi cant impact on U.S. tariff preferences, and the return to their lobbying activities

> 4See more details on tariff preferences in the empirical section.

> 5In this paper, the meaning of Latin America is extended to include Caribbean countries as well.

> 6On average 57 percent of Latin American exports were directed to the U.S. in the period of 1997-2000.

> 7Around 82 percent of preferential exports entered under the NAFTA regime (Mexico only) in the year 2000; CBTPA countries followed with 6 percent; GSP accounted for 4 percent; CBI for 3 percent and the Andean act regime for 2 percent of Latin America preferential exports to the United States. Other special import regimes, such as the Civil Aircraft, Pharmaceuticals and Dyes accounted for the rest of non-programclaimed imports of the US from Latin America.

4
has been estimated to be on average about 50 percent.<sup>8</sup> At the same time, they also found that Latin American lobbying is not the main force behind U.S. tariff preferences since it explains only a small part of the tariff preferences variation. None of these studies, however, investigates the importance of foreign exporters and domestic importers’ lobbying efforts in determining the U.S. tariff preferences.<sup>9</sup> The remainder of the paper is organized as follows. Section 2 describes the notation and the political economy game used to determine tariff preferences granted to a group of preferential partner countries. Section 3 discusses the empirical strategy followed to evaluate the predictions of the model. Section 4 presents the empirical results as well as a series of robustness checks. In section 5 the paper is concluded.

# 2 The Model

## 2.1 Notation and Basic Set up

To analyze the role of domestic importers and foreign exporters in the determination of a country’s tariff preferences, we consider a model in which a Home country, the rest of the world (ROW) and a group of n preferential partner nations interact. Assume that m different homogenous goods exist. Superscript j denotes preferential partners, while subscript k indicates the type of good. For tractability reasons, the stylized assumptions used on the demand and the supply sides of the model reduce the choice of tariff preferences to a partial equilibrium set up.

Assume that Home is a small economy<sup>10</sup> in which consumers maximize a quasi-linear

> 8In their model, these large returns are due to the low weight of aggregate social welfare in the U.S. government’s objective function.

> 9Gawande, Krishna and Robbins (2004) focus on lobbying by foreign exporters and domestic producers in the determination of the U.S. MFN tariffs. Thus, they do not investigate the effects of lobbying by importers or the determination of preferential tariffs, which is the focus of this paper.

> 10In this section, domestic or home economy is used to denote the U.S. economy. Preferential partners denote Latin American countries.

5
utility function Good zero is the numeraire. Given this functional form, there is no income or substitution effect on the demand for non-numeraire goods. The supply side is a speci fi c-factor model where primary inputs are a sector-speci fi c capital and mobile labor. Production of good zero uses labor only under constant returns to scale, and in an interior solution this fi xes the wage rate. Thus, there is no general-equilibrium effect on the supply of non-numeraire goods either.

Our model follows Maggi and Rodriguez-Clare (2000) by assuming that foreign-produced goods can be sold in the Home country only if imported by domestic agents that supply the sector-speci fi c factor needed to conduct trade, without further costs. We call these agents importers, and they earn rents only if the tariffs applied on goods originating in preferential partner countries are lower than the corresponding MFN tariffs.<sup>11</sup> Note that importers of a particular good k can import this good from any preferential partner country but can not import other goods besides k.

Owners of a speci fi c factor might be politically organized or not. For simplicity, we assume that resident owners of speci fi c capital have mass zero in the population and, consequently, domestic politically organized groups do not consider their consumption bundle or share of tariff revenue when lobbying the Home’s government.

The political game takes the following form. Politically organized owners of sector speci fi c capital, whether nationals or foreigners, lobby the Home’s government for advantageous trade policies. In order to simplify the setup, we will assume that ROW imports (imports from non-preferred countries) are sufficiently large to absorb the increase in preferential imports that would result from preferential tariffs. The ‘large market’ assumption ensures that there is no political rivalry between Home country’s producers and preferential partners since exports that receive preferential treatment do not change domestic prices. For Home’s

> 11We assume that trade tariffs are the only policy instrument in this economy. Thus, quota rents do not exist in this case.

6
import-competing producers, this means asking for MFN tariffs on imports, whereas for foreign producers and Home’s importers, it means asking for either MFN or preferential The notation used in the model is as follows. Let tk denote Home’s ad-valorem MFN tariff on good k and let t<sup>j</sup> k<sup>�[0, tk]bethepreferentialad-valoremtariffappliedongoodk</sup> originating in preferential partner country j. Tariff preferences granted to imports of good k originating in country j can be described as The share of the rents due to preferences α<sup>j</sup> k<sup>that accrue to importers of good k is denoted</sup> by ρ<sup>j</sup> k<sup>.Thus, the share of the rents that accrue to exporters of good k from country i is 1−ρj</sup> k<sup>.</sup> Let Ck<sup>ej(tk, tj</sup> k<sup>) be the contribution schedule offered by the exporter lobby kfrom country</sup> j to the Home’s government, and let Ck<sup>ij(tk, tj</sup> k<sup>)bethatofferedbytheHome’simporter</sup> lobby for preferences granted to good k originating in country j. Importers’ lobby can be thought of as representing the service fi rms involved in the distribution of imported goods. Similarly, let Ck<sup>p(tk) be the contribution schedule offered by Home’s producers of good k.12All</sup> contribution schedules are assumed to be differentiable at least around the equilibrium point. Grossman and Helpman (1994) show that differentiability of the contribution schedules is sufficient to guarantee that the equilibrium tariffs are robust with respect to non-binding communication among the lobbies, i.e., that the equilibrium tariffs are coalition-proof. In the context of tariff preferences to Latin America, this means that importers and exporters can share information about their preferences and, as long as there are non-binding agreements among them, the equilibrium preferential tariffs described in the following sections are stable to communication among them.

The exporter lobby (j, k)’s objective function, net of contribution, is given by vk<sup>ej</sup> =

> 12Note that domestic producers just lobby for MFN tariff since preferences do not change domestic prices.

7
π<sup>ej</sup> k<sup>(tk, tj</sup> k<sup>) −C</sup> k<sup>ej(tk, tj</sup> k<sup>).InthecaseofHome’simportersofgoodk,thelobby’sobjective</sup> function for preferences to goods originating in country j is vk<sup>ij=πij</sup> k<sup>(tk, tj</sup> k<sup>) −C</sup> k<sup>ij(tk, tj</sup> k<sup>).</sup> Likewise, Home country producer of good k’s objective function is denoted by vk<sup>p= πp</sup> k<sup>(tk) −</sup> C<sup>pTheprofitfunctionofthelobbiescanbewrittenasfollows,</sup> k<sup>(tk).</sup> where p<sup>w</sup> k<sup>standsfortheworldpriceofgoodk,mj</sup> k<sup>denotestheimportsofgoodkfrom</sup> country j, lk<sup>jistheexporter’slaborcosttoproducemj</sup> k<sup>,andykisthedomesticoutput</sup> of good k.<sup>13</sup> The price that exporters receive when preferences are granted is denoted by p<sup>ej</sup> k<sup>=</sup> �1 + �1 − ρ<sup>j</sup> k� α<sup>j</sup> k� p<sup>w</sup> k<sup>.Home’s producers and consumers face instead prices represented</sup> by pk = [1 + tk] p<sup>w</sup> k<sup>.The Home’s government picks an m × (n + 1) matrix of preferential and</sup> MFN tariffs maximizing the following objective function: where t<sup>j</sup> = (t<sup>j</sup> 1<sup>, ..., tj</sup> m<sup>)isthevectorofpreferentialtariffsgrantedtopartnerjandt=</sup> (t1, ..., tm) is the vector of MFN tariffs. The sets I, E and P represent the set of importers, exporters and domestic producers that are politically organized. W (t<sup>1</sup> , ..., t<sup>n</sup> , t) denotes the aggregate social welfare function which can be de fi ned as follows:

> 13Note that labor costs are not constant. However, the fact that the labor wage rate is constant implies that the derivative of pro fi t functions with respect to tariffs does not affect labor costs according to the Envelope Theorem.

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where CS (t) denotes consumer surplus, TR (t<sup>1</sup> , ..., t<sup>n</sup> , t) represents tariff revenues, and PP (t<sup>1</sup> , ..., t<sup>n</sup> , t) denotes a political process. The latter will be explained in details below. The tariff revenue and consumer surplus can be written in the following manner: where mk stands for the imports of good k.<sup>14</sup> Grossman and Helpman (1994) assume that even in the protection "for sale" context the fraction of aggregate income exchanged for political in fl uence (contributions) remains within the country so that political contributions just imply a change of income distribution without welfare consequences.<sup>15</sup> Likewise, they do not include in their framework the possibility of income losses due to the political process of implementing trade restrictions. In our case, income losses might arise when the political discussions about trade restrictions gain ground over welfare enhancing topics (like education, health and infrastructure) in the legislature agenda.<sup>16</sup> We incorporate possible income losses to the Home country due to the political

> 14The ’large’ market assumption guarantees that mk does not change due to preferential trade.

> 15This is due to the use of identical quasi-linear preferences. See Dixit, Grossman and Helpman (1997) for a common agency game where income distribution matters.

> 16Shleifer and Vishny (1993) maintains that the ilegality status of operations that involve corruption forces corrupted politicians and public officials to concentrate the public or legislature agenda on issues where the danger of being caught is lower. Not rarely the preferable issues in corrupted politicians’ agenda are the least efficient manners to redistribute income to politicians or interest groups. In this sense, one can conclude that it might be easier to corrupt public officials in the setting of trade policy and defense projects than in the allocation of resources to education and infrastructure. Mauro (1995) provides evidence of the deleterious

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process in the following term: where γk � (0, 1].<sup>17</sup> Expression (6) indicates that the higher the tariff rents involved in determining MFN and preferential tariffs, the higher is the welfare loss due to the political process.<sup>18</sup>

# 2.2 The Second Stage: Sharing the Tariff Preferences Rents

The vector of preferences α is determined in the fi rst stage. Assuming that the government grants positive preferences to the imports of good k originating in country j, i.e., 0 < α<sup>j</sup> k<sup>�tk, the share of rents due to preferences acquired by importers and exporters is de-</sup> termined in the second stage. A common situation in the international arena is a developed country granting preferences to a group of developing countries. In many cases a signi fi cant share of the rents arising from the tariff preferences granted by the developed nation are acquired by domestic importers, and exporters located in the developing countries instead enjoy only a small share of the rents.

Olarreaga and Ozden (2004) show evidence that the degree of market power enjoyed by U.S. importers in dealing with African exporters implies that countries that are members of the AGOA (African Growth and Opportunity Act) enjoy only a small fraction<sup>19</sup> of the potential bene fi ts from tariff preferences granted by the U.S. Krishna, Erzan and Tan (1994) show a similar pattern in the tariff preferences granted by the U.S. to apparel goods originating

> effects of corruption on income through the reduction of the investiment rate.

> 17 Assuming that γk � (0, 1] avoid some expressions to have a negative sign for feasible ranges of important parameters. For instance, see the expression de fi ned by the parameter β<sup>j</sup> k<sup>insection(4).</sup>

> 18Facchini, Van Biesebroeck and Willmann (2003) show that allowing for imperfect rent capturing due to the application of trade instruments that do not generate rents to domestic citizens can be important when testing models a la Grossman and Helpman (1994). For simplicity, other trade instruments are not considered in this paper.

> 19On average African exporters enjoy 33 percent of the potential tariff preferences granted by the U.S. This share is much lower for exporters located in the poorest countries that are members of the AGOA.

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in Hong Kong, China.

Following the empirical evidence, our model assumes that Home’s importers can collusively determine the share of the rents accruing to importers and exporters.<sup>20</sup> Thus, the share of rents that accrue to importers �ρ<sup>j</sup> k� is determined by maximizing π<sup>ij</sup> k<sup>(tk, tj</sup> k<sup>)21with</sup> respect to ρ<sup>j</sup> k<sup>subjecttotheconstraintthat0<ρj</sup> k<sup>�1.22</sup> The interior solution to this problem can be written as follows: Clearly, the direct effect of an increase in ρ<sup>j</sup> k<sup>alsoincreasesimporters’profits.Equation</sup> (7) also highlights the presence of an indirect effect, where an increase in ρ<sup>j</sup> k<sup>hasanegative</sup> effect on the price perceived by exporters (p<sup>ej</sup> k<sup>),leading,consequently,toadecreaseinthe</sup> quantities exported and the importers’ pro fi ts. Simple algebra allows equation (7) to be rewritten as follows: ∂p<sup>ej</sup> <u>k</u> This implies that<sup>−αj</sup> k<sup>p</sup> k<sup>w,and,throughsomemanipulations,equation(8)canbe</sup> ∂ρ<sup>j</sup> k<sup>=</sup> rewritten as where �<sup>j</sup> k<sup>istheelasticityofexportsupplyofgoodkfromcountryj,i.e.,�j</sup> k<sup>=</sup> ∂m∂p<sup>ej</sup> k<sup>j</sup> <u>k</u> mp<sup>ej</sup> <u>k</u><sup>j</sup> k<sup>.</sup>

> 20Export supply of the ROW is perfectly elastic. Thus, whether Home’s importers collude or not does not affect Home’s consumers and producers equilibrium prices.

> 21See equation (2) for a description of this term.

> 22The game between importers and exporters could be modelled in a different way. Three reasons, however, made us pick this particular choice. First, we did not want to estimate other sectorial parameters related to the bargain weights of importers and importers. Second, the empirical section requires a manegeable prediction of the tariff preferences. Last, the tariff preferences predicted by the model match the stilyzed facts noticed in Kee, Olarreaga and Silva (2003).

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Since 0 < ρ<sup>j</sup> k<sup>�1,equation(9)impliesthefollowing"switchingequation"forρj</sup> k<sup>:23</sup> Equations (9) and (10) indicate that if �<sup>j</sup> k<sup>></sup> α1<sup>j</sup> k<sup>thenthe greater�j</sup> k<sup>the lower ρj</sup> k<sup>.Clearly,</sup> when the exporter’s supply elasticity is high given the tariff preference, a reduction of ρ<sup>j</sup> k<sup>in</sup> response to an increase in �<sup>j</sup> k<sup>producesthetwoeffectsintheimporters’profitsdescribedby</sup> equation (7). The direct effect represents a decrease in the price received by importers, which reduces their pro fi ts. On the other hand, the indirect effect represents an increase in the quantity imported, which increases their pro fi ts. In this case, the indirect effect dominates the direct effect since the proportional increase in the imported quantity is greater than the reduction in the importers’ price. This indicates that exporters with high supply elasticity receive larger shares of the rents generated by tariff preferences than exporters with low supply elasticity.

# 2.3 The First Stage: Determining Tariff Preferences

In the fi rst stage, the government chooses MFN and preferential tariffs for each good k and for each partner country j. In the second stage we have solved for the share of rents that accrue to importers and exporters, and the government will take them into account in determining the tariff preferences. An important question is whether or not importers and exporters would lobby for MFN and preferential tariffs since both instruments affect the trade preferences granted by Home’s government. In what follows we show that importers and exporters lobby only for preferential tariffs, as long as equilibrium preferential tariffs are not full, i.e., 0 < t<sup>j</sup> k<sup>�tk.ThisresultresemblestheoneobtainedbyDixit(1996)where</sup> domestic interest groups do not lobby for tariffs when production subsidies are also for ‘sale’. Import subsidies are rarely seen in practice so that MFN and preferential tariffs are

> 23In fact we could have written a Kuhn-Tucker problem in the beginning of this section.

12
~~—~~ «= ~~(—~~ ) ~~-~~ e ~~d~~ co) ( ~~—]~~ (
where Ik<sup>ej,I</sup> k<sup>iandI</sup> k<sup>paredummyvariablesthatindicatewhetheranexporter,importer</sup> and Home’s producer lobby is organized or not, respectively. The effect of an increase in the preferential tariff of good k originating in country j on the government’s objective function can be divided in the following elements: (i) Expression (15a) represents the effect of an increase in the preferential tariff on the foreign exporters’ pro fi ts; (ii) Expression (15b) describes the effect of an increase in the preferential tariff on Home’s importers; (iii) Expression (15c) represents the effect of an increase in the preferential tariff on the tariff revenue and the political process term. Notice that using equation (10) we can fi nd that expressions (15a) and (15b) are negative, while expression (15c) is positive. This is intuitive since an increase in preferential tariff t<sup>j</sup> k<sup>impliesadecreaseintariffpreferenceαj</sup> k<sup>,which</sup> implies that the pro fi ts of exporters and importers of good k originating in country j also decrease. At the same time, however, an increase in preferential tariff t<sup>j</sup> k<sup>alsoincreasesthe</sup> summation of the tariff revenue and the political process term.

Similarly, the effect of an increase in the MFN tariff applied to good k on the government’s objective function can be expressed in the following terms: (i) Expression (16a) describes the effect of an increase in the MFN tariff on the exporters’ pro fi ts; (ii) Expression (16b) represents the effect of an increase in the MFN tariff on the importers and domestic producers’ pro fi ts; (iii) Expressions (16c) and (16d) describe the effect of an increase in the MFN tariff on consumer surplus, tariff revenue and the political process term. Notice that 14
a change in the MFN tariff applied to good k changes the exporters and importers’ pro fi ts related to trade of good k with any of the preferential partner countries.

It is clear that expressions (15a)-(16d) depend on the terms ∂∂tρ<sup>j</sup> k<sup>j</sup> <u>k</u><sup>and</sup> ∂∂tρk<sup>j</sup> <u>k</u><sup>which, according</sup> to equation (10), itself will depend on whether or not �<sup>j</sup> k<sup>></sup> α1<sup>j</sup> k<sup>.Thus,thefollowingtwo</sup> sections discuss the equilibrium of tariff preferences and MFN tariffs using conditions (12)(14) for each of these cases.

Lobbying for Preferential Tariffs Assume for tractability that the elasticity of export supply of any partner country and good is constant. Using conditions (12), (14), and equation (15) the interior solution �0 < t<sup>j</sup> k<sup>< tk</sup> � of the government maximization problem with respect to t<sup>j</sup> k<sup>canbewrittenasfollows:</sup> <u>1</u> �<sup>j</sup> <u>k 1</u> where β<sup>j</sup> k<sup>=</sup> a(1+γk) �(1 + a) 1+�<sup>j</sup> k<sup>I</sup> k<sup>ej+ (I</sup> k<sup>i+ a)</sup> 1+�<sup>j</sup> k<sup>−a (1 + γk)</sup> �.<sup>25</sup> Details on how to obtain equation (17) are provided in Appendix 1. We can explicitly solve for α<sup>j</sup> k<sup>rewriting</sup> equation (17) as follows: The original Kuhn-Tucker problem suggests the existence of other solutions as well. The complete set of solutions is described by the following expression.

> 25Note that if γk is greater than one then β<sup>j</sup> k<sup>is unambiguously lower than zero for a > 1.Empirical papers</sup> on the political economy of trade policy have estimated the value of a to be much greater than one. See Gawande and Krishna (2002) for a survey of these results.

15
According to equation (19) α<sup>j</sup> k<sup>isdifferentfromzero.</sup> Conditions <u>β</u><sup>j</sup> <u>k</u><sup>tkand</sup> (<sup>�</sup> k<sup>j−βj</sup> k<sup>)<</sup> <u>β</u><sup>j</sup> <u>k</u><sup>0areimpliedbytherestriction0<tj</sup> k<sup><tk.Giventheparametersa,γ</sup> k<sup>and</sup> (<sup>�</sup> k<sup>j−βj</sup> k<sup>)></sup> the political organizational dummies, the restriction �<sup>j</sup> k<sup>></sup> α<sup><u>1j</u></sup> k<sup>definesalowerboundtothe</sup> elasticity of export supply so that �<sup>j</sup> k<sup>></sup> �<sup>j</sup> <u>kβ</u><sup>−j</sup> k<sup><u>βj</u></sup> <u>k</u><sup>.</sup> Equation (17) provides valuable information about the economic effects of changes in political organization, export elasticities and in the weight attached by Home’s government on social welfare in the equilibrium tariff preferences when 0 < t<sup>j</sup> k<sup><tkand�j</sup> k<sup>></sup> α<sup><u>1j</u></sup> k<sup>.In</sup> this case, the political organization dummies (Ik<sup>ej</sup> and Ik<sup>i)haveapositiveeffectontariff</sup> preferences since importers and exporters bene fi t from them, and there is no counter-lobbying from domestic producers. On the other hand, the higher the weight of social welfare (a) in the government’s objective function, and the higher the income losses (γk) due to the political process necessary to implement trade restrictions, the lower are the tariff preferences. In both cases, the decrease on the level of tariff preferences is due to income losses, and, more generally, to losses in welfare, caused by positive tariff preferences.

Similarly, the higher export elasticities ��<sup>j</sup> k�, the lower is the level of tariff preferences. Increases in the export elasticities imply an increase in the fraction of tariff revenues that is lost by the domestic government, and is neither captured by exporters nor importers. In other words, the higher the export elasticities, the higher is the trade diversion induced by tariff preferences.

Lobbying for MFN tariffs We have just shown above how tariff preferences are determined in equilibrium if �<sup>j</sup> k<sup>></sup> α1<sup>j</sup> k<sup>.However,whetherexportersandimporterslobbyor</sup> not for MFN tariffs remains still unclear.<sup>26</sup> We show next that domestic producer lobbies are the only politically organized groups that have an interest at stake if 0 < t<sup>j</sup> k<sup>< tkfor any</sup> j.<sup>27</sup> In this case, conditions (12)-(14) imply that ∂t<sup><u>∂V</u></sup> k<sup>=</sup> ∂t<sup><u>∂Vj</u></sup> k<sup>=0since0<tj</sup> k<sup><tkforanyj.</sup> Thus, from condition (12) and expression (15) we have:

> 26The reverse is not true as can be seen from equation (19).

> 27If t<sup>j</sup> k<sup>= tkthentariffpreferencesarezeroandexportersandimportersneitherlobbyforthepreferential</sup> nor the MFN

16
For the details of the derivation, see Appendix 1.<sup>28</sup> Substituting equation (20) in equation (16) and setting it equal to zero, we can rewrite the fi rst order condition with respect to tk as follows: ∂m<sup>j</sup> <u>k</u> ∂m<sup>j</sup> <u>k</u> Clearly, ∂t<sup>j</sup> k<sup>=−</sup> ∂tk<sup>becausechangesintheMFNandpreferentialtariffshaveasym-</sup> metric effect on exporters’ price p<sup>j</sup> k<sup>.Simplealgebraallowsequation(21)toberewrittenas</sup> follows: which is the same expression obtained for a small economy with no preferential tariffs, with the addition of the political loss term described by equation (6). Notice that if γk = 0 for any k, equation (22) becomes simply proposition (2) in Grossman and Helpman (1994). Thus, exporters and importers do not lobby for MFN tariffs if 0 < t<sup>j</sup> k<sup>< tk.29</sup> What is the intuition behind this result? There are two main reasons why exporters and importers lobby only for preferential tariffs in this case. First, lobbying for MFN tariffs might lead to the same level of tariff preferences as lobbying for preferential tariffs, but it is likely to require higher contributions by the lobbies to compensate the government for

> 28Equation (20) is obtained by rearranging equation (29) shown in Appendix 1.

> 29Note that equation (22) implies that Ik<sup>pyk> aγ</sup> k<sup>mkso that tk> 0 as was assumed in the definition of the</sup> government’s maximization problem. Thus, only sectors whose domestic producers are politically organized may have preferential tariffs different from zero.

17
the higher efficiency cost of the policy. Second, lobbying for MFN tariffs bene fi ts not only the exporter of a particular country, but all the exporters of the homogenous good whose tariff changes no matter where they are from. The non-binding commitment nature of the game then implies that these positive externalities to other lobbies are not followed by a reduction in costs (contributions). Thus, as long as preferences are not full then exporters and importers lobby only for preferential tariffs.<sup>30</sup> If the domestic government grants full preferences (α<sup>j</sup> k<sup>=tkforsomej),thenthefirst</sup> order condition with respect to t<sup>j</sup> k<sup>implies that</sup> ∂t<sup><u>∂Vj</u></sup> k<sup>�0.Equation (20) can then be rewritten</sup> as an inequality and, following a procedure similar to the one used above, simple algebra allows equation (22) to be rewritten as follows: which implies that the MFN tariffs are at least as great as when there are no full preferences.<sup>31</sup> Thus, importers and exporters may lobby for MFN tariffs if the government grants full preferences.

Lobbying for Preferential Tariffs In this case equation (10) tells us that ρ<sup>j</sup> k<sup>=1.</sup> This implies that exporters will not contribute to obtain preferential treatment since they do not obtain any advantage in this case. Thus, the effect of an increase in t<sup>j</sup> k<sup>onthe</sup> government’s objective function can described as follows:

> 30Dixit (1996) shows that if production subsidies are also "for sale" then lobbies do not pay for MFN tariffs. In this case, production subsidies achieve the same objective than MFN tariffs, i.e., increase in pro fi ts, but it is cheaper since it does not distort so much allocations and welfare. Thus, the net bene fi t of lobbying for subsidies is higher than lobbying for MFN tariffs.

> 31In the case of full tariff preferences, expression (23) can be written using the home country import elasticity (�k) and the inverse of the import penetration ratio (zk), so that one obtains 1+tktk<sup>�</sup><sup><u>(</u></sup> a<sup>I</sup> <u>k(1</u><sup>pz</sup> −<sup>k−</sup> γk<sup>aγ</sup> )�kk<sup><u>)</u>.</sup>

18
which implies that a corner solution is always obtained since equation (24) does not depend on α<sup>j</sup> k<sup>.32</sup> The Kuhn-Tucker solution to this problem is the following: Expression (25) indicates that "full" or "null" preferences occur depending on whether one dollar of contributions from importers is worth more than the welfare weighted value of the fraction of a dollar of income lost due to politics as described by the expression Ik<sup>i−aγ</sup> k<sup>.Ifeitherimportersarenotpoliticallyorganized(I</sup> k<sup>i= 0)ortheproductofthe</sup> parameters a and γk is high, then any positive value of tariff preferences reduces the value of the government’s objective function. In this case, importers can not compensate the government for the losses in welfare when preferences are positive, and the government then grants null preferences, i.e., α<sup>j</sup> k<sup>=0.Onthecontrary,iftheweightofsocialwelfarein</sup> the government’s objective function (a) is low, welfare losses due to the political process are not signi fi cant (low γk), and importers are politically organized, then equilibrium tariff preferences are full<sup>33</sup> as described by α<sup>j</sup> k<sup>=min</sup> �tk, �<sup><u>1j</u></sup> k �. It is also worth noticing that contrary to equation (19) export elasticities do not play any role in this case, since preferential partners’ exports are not affected.

Lobbying for MFN tariffs Equation (25) indicates that the magnitude of the MFN tariff for good k depends on the sign of the expression Ik<sup>i−aγ</sup> k<sup>.Accordingtoequation(25)</sup> if Ik<sup>i−aγ</sup> k<sup>< 0thenαj</sup> k<sup>= 0.Usingconditions(12)-(14)wehavethat</sup>

> 32The case where Iki<sup>= γ</sup> k<sup>aisnotbeingconsideredsinceitisameasurezeroevent.</sup>

> 33Controlling for the restriction �<sup>j</sup> k<sup><</sup> α1<sup>j</sup> k<sup>.</sup>

19
Substitution of ρ<sup>j</sup> k<sup>= 1in equations (15) and (16),allows expression (26) toyield expres-</sup> sion (21), and, consequently, implies that equation (22) is also valid. Thus, importers and exporters do not lobby for MFN tariffs. However, if Ik<sup>i−aγ</sup> k<sup>> 0 and tk<</sup> �1<sup>j</sup> k<sup>then expression</sup> (23) is valid and importers and exporters may lobby for MFN tariffs as well.

# 3 Estimation Strategy and Data

## 3.1 Empirical Model

We can use our model to test whether Latin American exporters and U.S. importers lobbying are important forces behind the tariff preferences granted by the U.S. to that region. In carrying out the empirical analysis of the model we need to address two important issues. First of all, importers and exporter may lobby for both preferential and MFN tariffs. This has important effects on the scope of the empirical analysis. The second issue is related instead to the challenges involved in the estimation of the predicted tariff preferences of the model, since they depend on whether the condition �<sup>j</sup> k<sup>></sup> α<sup>j</sup> k<sup>(a,γk</sup> <u>1</u><sup>,I</sup> k<sup>ej,I</sup> k<sup>i)issatisfiedornot.</sup> With respect to the fi rst issue, the framework used in this paper predicts that exporters and importers may lobby for MFN tariffs only if preferences are full. Thus, in general one can assume that importers and exporters only lobby for preferential tariffs. Following this line of argument, we ignore possible importers and exporters lobbying activities towards MFN tariffs, and, consequently, the following analysis concentrate on their lobbying efforts towards preferential trade as described by equations (19) and (25).<sup>34</sup> The second issue is handled by using quartile thresholds of the product of tariff preferences and elasticities of export supply (�<sup>j</sup> k<sup>αj</sup> k<sup>)to determine whether the observation for a particular</sup> good k originating in country j satis fi es the restriction �<sup>j</sup> k<sup>></sup> α1<sup>j</sup> k<sup>.Ifweassume,forinstance,</sup>

> 34The interested reader on lobbying for MFN tariffs is referred to the studies of Goldberg and Maggi (1999), Gawande and Bandhyopadhyay (2000), and Krishna, Gawande and Robbins (2004) for more on this topic.

20
that the third quartile of the product �<sup>j</sup> k<sup>αj</sup> k<sup>isusedtodeterminewhetheranobservation</sup> satis fi es the restriction �<sup>j</sup> k<sup>></sup> α1<sup>j</sup> k<sup>,thenonlythegroupofobservationswhoseproductoftariff</sup> preference and elasticity of export supply is greater than the third quartile have predicted tariff preference described by equation (19). Otherwise, the predicted tariff preference is described by equation (25). Thus, the approach followed in this paper does not test whether the condition �<sup>j</sup> k<sup>></sup> α<sup>j</sup> k<sup>(a,γk</sup> <u>1</u><sup>,I</sup> k<sup>ej,I</sup> k<sup>i)issatisfiedbythedatabut,insteadassumesthatthegroup</sup> of observations whose product �<sup>j</sup> k<sup>αj</sup> k<sup>isgreaterthanthequartilethresholdistheresultofa</sup> different data generating process from observations that do not satisfy this condition.

We can proceed as follows with our empirical analysis. For observations that satisfy the condition �<sup>j</sup> k<sup>></sup> α1<sup>j</sup> k<sup>,equation (19) isthe one to be estimated.Adding an error term and after</sup> some manipulations, equation (19) can be rewritten as follows: Note that we assume the political cost parameter (γk) to be constant across goods so that we have an estimable equation. Moreover, it is clear from equation (27) that the endogenous variable is bounded from below at zero and, in fact, many observations hit this boundary. Therefore, the endogenous variable is censored at zero and a Tobit estimation has to be performed. The model implies the following restrictions on the parameters in equation (27): φ0 > 0, φ1 < 0 and φ2 < 0. The estimation of the coefficients will then be used to compute the parameters a and γ.

For observations that satisfy �<sup>j</sup> k<sup>�</sup> α1<sup>j</sup> k<sup>weneedinsteadtoestimateequation(25),which</sup> assuming that tk <<sup><u>1</u></sup> �<sup>j</sup> k<sup>for any pair (j, k), and adding an error term can be written as follows:</sup> 21
where θ1 is expected to be positive and θ0 is a constant as suggested by equation (25).

# 3.2 Data

The estimation of equations (27) and (28) requires information on U.S. importers and Latin American exporters’ political organization, and data on elasticity of export supply and tariff preferences by industry and by Latin American country. Data on MFN and preferential tariffs as well as exporters’ political organization cover the years from 1997 to 2000. The paper employs data on importers’ political organization from the period 1991-2000. By calculating the average of the data over these years, we perform cross-section regressions to estimate the coefficients of equations (27) and (28). All the variables are organized at the HS 8-digit and ISIC 3-digit levels. Several issues related to the data set are discussed at length next.

MFN and Preferential Tariffs MFN and Preferential tariffs are calculated using customs data provided by the United States International Trade Commission (USITC). The original data is available at the tariff line level (HS 8-digit level) and covers the period between 1997-2000. Before proceeding with the calculation of the MFN and preferential tariffs, we average out the observations for these four years by HS 8-digit code and by country. U.S. MFN tariffs are determined by the ratio between duties paid on U.S. imports and the value of U.S. imports from all over the world that entered under the MFN regime for each HS 8-digit line. Similarly, preferential tariffs are determined by the ratio between duties paid on U.S. imports and the value of U.S. imports by Latin American country and by HS 8-digit line.

Using actual duties paid and the value of imports to calculate tariffs allows the determination of actual tariff preferences (i.e., those actually granted at customs and not ‘on paper’).<sup>35</sup> The data on MFN and preferential tariffs has been aggregated at the ISIC 3-digit

> 35The data on MFN and preferential tariffs used in this paper is the same one used in Kee, Olarreaga and Silva (2003). The interested reader can obtain information about the products and countries which were granted the highest and lowest preferential tariffs in that paper.

22
level as well. The value of the 8-digit HS exports from each Latin American country to the U.S. is used as weights to aggregate the data on tariffs from the 8-digit of the HS to the 3-digit of the ISIC.

Political Organization of Importers Previous papers on the political economy of trade have used corporate Political Action Committees (PAC) data for manufacturing fi rms to determined whether a sector is organized or not. These measures identify which domestic producers’ lobbies are capable of playing a signi fi cant role in the determination of trade policy. The model and the discussion shown above, however, made clear that the in fl uence played by exporters and importers might be very important in explaining tariff preferences. This paper is fi rst to elaborate a measure of political organization for importers. Using the lobbying in service database kindly provided by Kishore Gawande, we identify which manufacturing and agriculture products present organized lobbying by service fi rms. The measure of importers’ political organization is driven by the requirements of the theoretical model presented above, and which is summarized by the variable Ik<sup>i.</sup> Gawande (2002) organizes service fi rms’ corporate PAC contributions for the fi ve election cycles between the years of 1991 and 2000. Contributions reach a total of $483 million over the fi ve election cycles period and are organized at the SIC 4-digit level. Of course, not all of the contributions paid can be directly imputed to in fl uence trade policy. For instance, it is hard to believe that fi nancial institutions and insurance companies lobby for trade purposes. Following this line of argument, only contributions from retail and wholesale fi rms are used to measure the political activity of service fi rms in this paper. Trade related contributions from service fi rms amount to $68 million during the period from 1991-2000. Before proceeding with the determination of the political organization variable, an average across the fi ve election cycles was taken by SIC 4-digit code.

The theoretical model requires importers’ to be either politically organized or not by agricultural and by manufacturing code. In order to fi lter contributions from SIC 4-digit service codes to the ISIC 3-digit and HS 8-digit agricultural and manufacturing codes we 23
proceeded as follows. First, we fi ltered the retail and wholesale fi rms’ data from the SIC 4- digit level to the North American Industrial Classi fi cation System (NAICS). Assuming that importers lobby according to the importance of each agricultural and manufacturing NAICS code in its production process, the 1997 U.S. Input-Output matrix provided by the Bureau of Economic Analysis (BEA) was used to determine the level of service fi rms’ contributions by each agricultural and manufacturing NAICS code. Finally, a concordance between the Input-Output codes and the HS 10-digit codes provided by the BEA was used to map the contributions to the international trade data system.

Political organization of importers for each agricultural and manufacturing ISIC 3-digit and HS 8-digit code was determined using thresholds following Goldberg and Maggi (1999) and Krishna, Gawande and Robbins (2004). The fi rst, second and third quartiles of the importers’ distribution of political contributions were used to determine which manufacturing and agricultural sectors present politically organized importers. For example, using the fi rst quartile of the distribution of political contributions to determine whether importers are organized or not means that those sectors with lower (higher) contributions than the one displayed by the fi rst quartile code are assumed to be not politically organized (are politically organized) so that Ik<sup>i= 0(I</sup> k<sup>i= 1) .</sup> Political Organization of Exporters The data set used to determine Latin American exporters political organization is the same one used in Kee, Olarreaga and Silva (2003). Latin American exporters contribution data were provided by the U.S. Department of Justice under the legislation known as the Foreign Agent Registration Act (FARA). First, the foreign lobbying expenditure data related to trade on agricultural and industrial goods were separated from those involving trade in services and other types of foreign lobbying. Kee, Olarreaga and Silva explain in details the procedure used to select contributions related to trade in goods. The same process was used for fi rms’ and governments’ contributions. Then, each lobbying expenditure related to trade in goods was mapped into 3-digit ISIC industries. Latin American governments’ contributions were spread across sectors using sectorial 24
exports to the rest-of-the-world (i.e., excluding the United States). This methodology was chosen to avoid simultaneity issues between the exporters’ organization dummy and the tariff preferences.<sup>36</sup> This mapping process was repeated for each entry found on the FARA report for 33 countries in Latin America. We used the FARA reports for 1997, 1998, 1999 and 2000. Finally, we calculated the average lobbying expenditure over this four year period by 3-digit ISIC industry and by country. Trade related FARA contributions by Latin American exporters reached 120 million dollars during this period when both fi rms’ and governments’ contributions are included.

After selecting the contributions related to trade, a series containing exporters’ political contributions from private fi rms and Latin American governments was organized at the ISIC 3-digit level. Political organization of exporters is determined using quartile thresholds of the distribution of political contributions. After determining the exporters’ political organization at the ISIC 3-digit level we replicated the value of the variable Ik<sup>iattheHS8-digitlevel.</sup> Elasticities of Export Supply Data on elasticities of export supply was kindly provided by Marcelo Olarreaga. The elasticity data are described in Kee, Nicita and Olarreaga (2004). They estimate elasticities of export supply at the HS 6-digit and ISIC 3-digit levels for about 118 countries. They present elasticities of export supply for most Latin American countries. Dividing Latin America in regions<sup>37</sup> allow us to use the regional export weighted average of the export elasticities in a region to fi ll the gap for those Latin American industry codes missing in their study. In the cases a regional weighted export elasticity is not available to substitute the elasticity for a particular commodity, we use the export weighted average elasticity of Latin America instead. The elasticities of export supply at the HS 8-digit level used in this study are replications of the values obtained by Kee, Nicita and Olarreaga (2004) at the HS 6-digit level.

> 36More details about possible endogeneity of the organization dummies are provided in the estimation techniques section.

> 37Latin America is divided in South America, Central America and Caribbean.

25
Estimation Techniques The variables on the right-hand side of equations (27) and (28) may present endogeneity problems. The usual instruments applied in the literature, such as sectorial fi rm concentration and unionization measures, to deal with the possible endogeneity of the importers’ organization dummy are not available for service sectors. The construction of these measures for service sectors (we believe) is beyond the scope of this paper. Moreover, Maggi and Goldberg (1999) and Mitra et al. (2003) do not have their results signi fi cantly affected when they assume that the domestic producers’ organization dummy is exogenous. Thus, this paper assumes that importers’ and exporters’ political organization variables do not present endogeneity problems.

Equations (27) and (28) are estimated using a Tobit approach. The standard errors of the government’s weight on social welfare (a) and the political cost parameter (γ) are calculated using the delta method.<sup>38</sup> Since the data on tariff preferences are constructed at the tariff line (HS 8-digit levels) then a serious heteroscedasticity problem due to group aggregation may occur when estimating the model at the ISIC 3-digit levels. As discussed at length in Kee, Olarreaga and Silva (2003) the method suggested by Dickens (1990) is used to control for heteroscedasticity problems.

The estimations of the elasticities of export supply presented in Kee, Nicita and Olarreaga (2004) are quite precise, and almost all of them are signi fi cant at the 1% and 5% levels. Moreover, the range of their point estimates is quite large [0.02, 302] and, although most of them are very precise, their standard errors (which are obtained by bootstrapping) can vary considerably [0, 1340]. The only method available to correct any remaining errors-in-variable problem when appropriate instruments are not present would be to apply the procedure described in Gawande (1997). Applying his method, however, would decrease the sample size dramatically. Moreover, it is not clear whether the bene fi ts in this case are superior to the costs given that we assume that the political organization variables are exogenous.

> 38This paper uses the delta method to obtain the standard errors of structural parameters of the model since the dependent variable (tariff preferences) is censored and the use of Non-linear Least square would prevent us from measuring important effects of the explanatory variables (organization dummies and elasticties) on tariff preferences. Moreover, least square estimates in the case of censored data is likely to be inconsistent. See Wooldridge (2002, chapter 16) for more on this.

26
Thus, the results presented in the empirical section do not correct for errors-in-variables in the elasticity data.

# 4 Results

Table A0 shows the summary statistics for the variables used in our empirical analysis. The sample mean of the U.S. MFN tariffs is 6.7%. The sample mean of the U.S. preferential tariffs applied to Latin American exports is 3.8%. In the case of the elasticities of export supply, the sample mean is 12.248. The main empirical results of the paper are presented in tables 1-6. The results shown in these tables use data organized at the HS 8-digits level and under the assumption that the errors are spherical. We leave the discussion of the presence of non-spherical errors to the next section. The total number of observations at the HS 8-digit level is 14,372.

Tables 1 and 2 present the results of Tobit regressions for equations (27) and (28), respectively, using the fi rst quartile of the product of elasticities of export supply and tariff preferences to divide the sample. As explained in detail, the observations for which the product of the elasticity of export supply and tariff preference is greater than the value of the fi rst quartile threshold should have tariff preferences predicted by equation (27). Otherwise, they should have tariff preferences predicted by equation (28). Similarly, tables 3 and 4 and tables 5 and 6 show the results of Tobit regressions for equations (27) and (28) using the second and third quartiles of the product of elasticities of export supply and tariff preferences to divide the sample, respectively. The results shown in tables 3-6 are robustness checks to the results presented in tables 1 and 2.

The coefficients’ estimates shown in table 1 con fi rm the basic predictions of the theoretical model since coefficient φ0 is positive and coefficients φ1 and φ2 are negative. All estimates are signi fi cant at the 1% level and they are robust to the choice of thresholds which determines the value of the political organization dummies of exporters and importers. Since coefficients φ1 and φ2 have the predicted signs and are all signi fi cant, we then conclude that domestic 27
importers and foreign exporters’ lobbying have a signi fi cant impact on the determination of the U.S. tariff preferences granted to Latin America.<sup>39</sup> Moreover, the estimation of the coefficients φ1 and φ2 in equation (27) provides an estimate of the U.S. government’s weight on social welfare (a) and the political cost parameter (γ). Using the results provided in table 1, the estimates of the structural parameter a range from 1 to 29. The latter is by far the greatest value obtained for the structural parameter a in our regressions. By calculating the standard errors of the parameter a through the delta method, we can verify that all the estimates of this parameter are signi fi cant at the 1% level. The estimates of the parameter γ also have the correct sign, and we can verify that they are signi fi cant at the 1% level by using the Delta Method to calculate their standard errors. The estimates vary considerably depending on the thresholds used to determine the organization dummies.<sup>40</sup> The results shown in table 1 indicate that parameter a is greater than one. As explained in section 3 this is problematic since estimates of the parameter a greater than one require that estimates of the parameter γ be lower than one to yield a perfect match between the estimations and the theoretical model. We interpret these fi ndings as follows. The estimates of the coefficients φ0, φ1, and φ2 con fi rm that the model is successful in explaining the cross section variation of the data. The parameters a and γ are constant across countries and products. They are then related to the level of trade preferences. The literature on the political economy of trade presents many similar problems in the estimation of structural parameters.<sup>41</sup> Thus, this paper shares some limitations with the literature.

Table 2 provides estimates of the coefficients in equation (28). Similarly to table 1, the estimates of the coefficient θ1 have the predicted sign and are signi fi cant at the 1% level. The estimates are also robust to different measures of the importers’ political organization

> 39Excluding export weighted average elasticities does not affect the results shown in this section. For the sake of brevity these results are not shown here. These results, however, are available upon request.

> 40We follow Maggi and Goldberg (1999) and Gawande, Krishna and Robbins (2004) in providing results of the regressions of equation (26) without a constant. Our model does not require a constant and so we decided to continue using the theory. The results using constant, however, are similar to the ones presented here and are available upon request.

> 41See the discussion in Gawande and Bandyopadhyay (2000) and Gawande, Krishna and Robbins (2004).

28
dummy. These results shown in table 1 con fi rm the fi ndings that the political organization of domestic importers is a fundamental determinant of the U.S. tariff preferences granted to Latin America. Moreover, the fi ndings shown in tables 1 and 2 indicate that the share of rents that accrue to importers and exporters really depends upon the relation between the elasticity of export supply and the tariff preference. In particular, U.S. importers tend to capture most of the rents generated by tariff preferences granted to Latin America since the model assumes that they enjoy a high degree of market power when facing Latin American exporters.

Tables 3 and 4, and tables 5 and 6 provide additional robustness checks to the results shown in tables 1 and 2 by varying the thresholds which determine the political organization of importers and exporters. The estimates of coefficients φ0, φ1 and φ2 present the expected sign and are signi fi cant at the 1% level, with the exception of the coefficient φ1 in the last column of table 5. Similarly, the coefficient θ1 has the expected sign and is always signi fi cant, a results which highlights once again the importance of domestic importers’ lobbying in the determination of tariff preferences. Moreover, tables 3 and 5 provide estimates of the structural parameters a and γ. In most cases, the estimates of the parameter a are signi fi cant and lower than fi ve. In all cases, the estimates of γ have the correct sign and are signi fi cant. These results con fi rm that importers’ and exporters’ lobbying is a signi fi cant determinant of the U.S. tariff preferences granted to Latin America.

The economic importance of importers’ and exporters’ lobbying can also be investigated using our estimates. As an example we use the estimation results provided in the fi rst column of table 1. The estimates of the coefficients φ1 and φ2, in conjunction with the sample mean of the elasticity of export supply, can be used to calculate the average effect of exporters’ and importers’ political organization on the tariff preferences granted to Latin America.<sup>42</sup> In this case, the joint political organization of importers and exporters decreases on average

> 42The important impact on preferences should not only be measured when preferences are positive, but also when they are negative. In this sense, the impact of political organization does not not need to be scaled down by the probability of the tariff preference being positive. Tariff preferences can be negative by the presence of rules of origin and non-tariff barriers as discussed in Kee, Olarreaga and Silva (2003).

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the U.S. tariffs applied to Latin American goods by 25 percent. Using the results provided in the fi rst column of table 5, we fi nd that the joint political organization of importers and exporters decreases the U.S. tariffs applied to Latin America by 18 percent. Clearly, lobbying is a relevant force in the trade relations between the U.S. and Latin America.<sup>43</sup> Additional Robustness Results The results shown in the last section use data on agriculture and manufacturing to check whether lobbying by U.S. importers and Latin American exporters increases tariff preferences. Most of the literature, however, does not use data on agriculture. Therefore, an interesting exercise is to test whether the results discussed above are sensitive to the exclusion of data on agricultural goods. The methodology employed to obtain the results in table 7 is analogous to that used in table 1. The only difference is that in table 7 the agricultural sector is excluded.<sup>44</sup> The results presented in this table are similar to the ones discussed above. Again, the coefficients of interest have the predicted sign and are signi fi cant at the 1% level. Moreover, the structural parameters a and γ are signi fi cant at the 1% level and have similar values to the ones shown in table 1. Thus, the inclusion of agricultural goods is not essential to the results obtained in this paper.

Mitra, Thomakos and Ulubasoglu (2003) suggest that more disaggregated elasticities should have higher values, and this assertion could imply lower estimates of the parameter a. Since we are fi rst to use elasticities data organized at the HS 6-digit level, this might be behind our results. In table 8 we adopt the same methodology used in table 1, but employ data organized at the ISIC 3-digit level. The method discussed by Dickens (1990) is used to control for heteroscedasticity problems. Most of the coefficients of interest have the predicted sign and are also signi fi cant. Again, the estimates of the structural parameter are comparable, in most cases, to the ones shown in the previous section. Thus, the level of aggregation of the data and the inclusion of agricultural goods seem not to affect substantially

> 43The mean MFN tariff in the sample used to construct table 1 is 6.3 percent. In the case of table 3 it is 9.7 percent.

> 44Similar results are obtained using similar methodology to the results shown on tables 3 and 5.

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our results.

Tables 1-8 show the result of regressions whose variables are strictly linked to the theoretical model discussed in section 3. Nevertheless, it is also important to check whether additional variables could change the estimates of the coefficients predicted by the theory, or whether an extended speci fi cation could outperform the predications of the theoretical model. Tables 9 and 10 present the results of regressions for extended versions of equations (27) and (28), respectively, using the fi rst quartile of the product of elasticities of export supply and tariff preferences to divide the sample. In both tables the value of Latin American exports to the world by country and by product is included to control for U.S. producers’ counter-lobbying triggered by preferential tariffs. In a sense, we are testing whether preferential imports affect or not the U.S. domestic prices. In table 10 we also include the exporters’ political organization dummy to check whether Latin American exporters have any in fl uence over the choice of tariff preferences even for observations that should satisfy equation (28). Country and program dummies are also used in the regressions shown in tables 9 and 10.<sup>45</sup> The results shown in table 9 con fi rm that even in the presence of control variables the coefficient φ0 is positive and the coefficients φ1 and φ2 are negative. Moreover, the estimates of the coefficients φ0, φ1 and φ2 remain signi fi cant at the 1% level. Table 10 con fi rms that the coefficient θ1 remains positive and is statistically signi fi cant even in the presence of different control variables. These fi ndings provide evidence that the estimates discussed in tables 1-8 are not sensitive to missing variables and that joint lobbying by importers and exporters is an important force in the determination of tariff preferences granted by the U.S. to Latin American countries.

The coefficients of the control variables shown in tables 9 and 10 have the sign predicted by economic intuition in most cases. However, they are not statistically signi fi cant in many occasions. Table 9 indicates that the value of Latin American exports indeed tends to decrease tariff preferences, but the effects of Latin American exports to the world may not be

> 45A Latin American country can belong to only one of the following programs: Generalized system of preferences (GSP), Caribbean Basin Initiative (CBI), Andean Act Regime, and North American Free Trade Area (NAFTA).

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statistically signi fi cant.<sup>46</sup> Table 10 con fi rms that foreign exporters’ lobbying efforts increase on average the tariff preferences. However, the effect of lobbying by foreign exporters on tariff preferences is not signi fi cant in any of the results shown in table 10. Thus, foreign exporters’ lobbying efforts do not signi fi cantly affect tariff preferences for observations that should satisfy equation (28).

Our last set of results compares the extended speci fi cations shown in tables 9 and 10 with the parsimonious model described in the fi rst column of tables 1 and 2, respectively. Pairwise likelihood ratio tests are used to determine whether an extended speci fi cation outperforms the model implied by the theory. The extended speci fi cation described in column 1 of table 9 does not outperform the parsimonious prediction described in equation (27). Thus, the effect of Latin American exports to the world does not seem to be so important in determining tariff preferences. However, the speci fi cations described in columns 2 and 3 of table 9 do outperform the tariff preferences described in equation (27). In fact, the speci fi cation which includes country and program dummies is preferred to all others. Similar phenomenon occurs when we compare the speci fi cations of table 10 with the tariff preferences predicted by equation (28). Hence, country and program dummies have a signi fi cant in fl uence over tariff preferences granted by the U.S. to Latin American countries.<sup>47</sup> The use of different thresholds to determine political organization and to divide the sample does not change the conclusions discussed above. These results are available upon request.

The results shown in column 3 of table 9 can be used to calculate the predicted share of the rents generated by tariff preferences that is captured by U.S. importers (ρ<sup>j</sup> k<sup>) according to</sup> equation (10). We calculated the parameter ρ<sup>j</sup> k<sup>at the HS 8-digit level using thefitted values</sup> of the regression shown in column 3 of table 9. The results shown on tables 11 and 12 are sample means of the parameter ρ<sup>j</sup> k<sup>calculated at the HS 8-digit level.Table 11 shows that the</sup>

> 46Note that the dependent variable in table (9) is 1+tktk<sup>−</sup> 1+αα<sup>j</sup> <u>k</u><sup>j</sup> k<sup>.Thus,apositivecoefficientforimports</sup> indicates that the higher the imports, the lower the tariff preference.

> 47This result is not surprising. For instance, the U.S. grants general tariff preferences to Colombia as part of its plan to reduce the production of drugs in that country. Similarly, tariff preferences granted to a caribbean country might also affect tariff preferences granted to other countries in that region. Thus, country and program dummies are relevant explanations for tariff preferences.

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ISIC 3-digit industries displaying the highest shares of the rents captured by U.S. importers are printing, publishing and allied products (ISIC 342), other non-methalic mineral products (ISIC 369), and paper products (ISIC 341), all with shares greater than 95 percent. Similarly, table 12 provides the sample mean by country of the share of the rents captured by U.S. importers. In this case, U.S. importers capture the highest shares of the rents generated by tariff preferences when facing exporters from Chile, Bermuda and Costa Rica. It is clear that whether we look at product or country averages, U.S. importers capture a very signi fi cant share of the rents generated by tariff preferences.

# 5 Conclusion

This paper adapts the fl exible framework provided by Grossman and Helpman (1994) to examine the pattern of tariff preferences granted by politicians in the presence of domestic importers’ and foreign exporters’ lobbying. The theoretical model assumes that domestic importers enjoy a high degree of market power when facing foreign exporters. The predictions of the model indicate that tariff preferences granted to a commodity k originating in country i depend upon the relation between the elasticity of export supply of country i in good k and the inverse of the equilibrium tariff preference. If the elasticity of export supply is greater than the inverse of the equilibrium tariff preference, then importers and exporters’ lobbying increases the tariff preference. Otherwise, only importers’ lobbying is capable of having some in fl uence over the decision on tariff preferences.

We tested the predictions of the model on Latin American exports to the U.S.. The estimation of both equations indicates that Latin American exporters and U.S. importers’ lobbying efforts are key determinants of the U.S. tariff preferences granted to Latin American countries. Furthermore, the empirical results also show that the U.S. importers tend to capture the bulk of the rents generated by tariff preferences granted by the U.S. to Latin American countries. Thus, our fi ndings imply that politicians should be cautious when designing preferential schemes aiming at bene fi ting developing countries. The empirical 33
results we obtained seem to be robust to changes in the de fi nition of political organization, to variations in the level of disaggregation of the data, and to the presence of agricultural goods in the sample.

What have we learnt from the analysis? First, joint lobbying by exporters and importers is responsible for signi fi cant increases in the tariff preferences granted by the U.S. to Latin America. However, importers are likely to be the engine behind the tariff preferences granted by the U.S. to Latin America since they capture the bulk of the rents generated by the tariff preferences. Second, developing countries that choose to support the formation of exporters’ lobbies should do so if the sectors in question are characterized by relatively high export elasticities. In any event, our results indicate that the presence of politically organized importers is an essential feature behind the growth of trade preferences granted to developing countries.

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