Endogenous tariff theory with fixed and variable trade costs

This paper adopts a political economy perspective to disentangle the simultaneous relationship between imports and protectionist trade policy.  The model is an extension of the “Protection for Sale” framework of Grossman and Helpman (1994) to include heterogeneous firms, monopolistic competition and fixed trade costs.  This is a richer economic environment than appears in the existing political economy literature and it offers the opportunity to examine counterfactual scenarios that influence decision making.  Imports, trade policy, industrial organization and political contributions are determined simultaneously in the equilibrium, and two new theoretical results emerge.  First, there is a negative relationship between the fixed trade costs and the level of the tariff.  Second, the relationship between the import-penetration ratio and the tariff is shown to be nonmonotonic.  These results do not depend on exogenous variation in political organization.  Rather, variation in the fixed trade costs generates industries that differ in their vulnerability to import competition and consequently place different values on protection.  The parameters of the model are estimated on U.S. industry-level data first using an instrumental variables technique, nonlinear GMM, and then according to a novel application of the indirect inference approach.  The estimates of the elasticity of substitution and the productivity distribution are broadly consistent with existing empirical studies, while the estimate for the relative political weighting within the government’s objective function differs markedly from the previous literature.  Specifically, these results suggest that U.S. trade policy reflects a political weight on import-competing producer interests that is approximately two-to-three times that on consumer welfare.