The safeguard clause, asymmetric information, and endogenous protection.

Transcription

1 T saguard claus, asymmtric inormation, and ndognous protction. ilipp Kolr and Mical O. Moor, Rvisd Marc ABSTRACT: Wn imports surg, govrnmnts otn ac a conlict among political objctivs. Ty sk simultanously to satisy protctionist prssurs troug incrasd taris, induc adjustmnt to orign comptition, and minimiz consumr costs o protction. T WTO s saguard claus can b viwd as a way to rsolv tis political objctivs conlict sinc it allows govrnmnts to or an implicit contract to protctd industris in ordr to induc tm to adjust. In tis papr, w sow tat wit asymmtric inormation about costs, protctd industris bav stratgically wic lads to undradjustmnt. T saguard claus tror cannot optimally rsolv t conlict among domstic political objctivs. Kywords: adjustmnt policy, asymmtric inormation, objctivs conlicts, protctionism, saguard claus. JEL Classiication: F13, L51 Dpartmnt o Economics - Univrsity o Montpllir - Franc - pkol@sc.univ-montp1.r. Dpartmnt o Economics / T Elliott Scool - Gorg Wasington Univrsity - Wasington DC USA - mom@gwu.du. (Corrsponding autor). W would lik to tank an anonymous rr or vry usul commnts on an arlir drat. Any rmaining rrors ar our own. 1

2 1. Introduction. Wnvr a country's pattrn o comparativ advantags sits, som industris incur losss. Economists av long argud tat it is nontlss gnrally optimal to lt t markt play its rol o rsourc allocation sinc r trad usually crats mor aggrgat gains tan losss vn i domstic irms ar orcd itr to lowr costs to rmain conomically viabl or lav t markt Wil r trad s supriority is widly accptd by conomists, slctiv protction masurs rmain among t most crisd tools usd by govrnmnts to rac tir political objctivs. olicy-makrs otn rcogniz opn trad s consumr bnits but l ty cannot ignor t comptitiv prssurs placd upon domstic import-compting industris. Govrnmnts tror av justiid protction by claiming tat domstic industris can rgain intrnational comptitivnss i tmporarily protctd rom orign comptition. On o t prim mans by wic tis tmporary protction may tak plac is t so-calld saguard claus. In tis papr, w analyz t saguard claus and argu tat tis protctionist outcom ariss out o a govrnmnt s attmpt to rsolv a conlict among domstic political objctivs. On on and, t govrnmnt sks to protct prssur groups. On t otr and, it wants to promot ovrall wlar. Ts two objctivs ar otn in conlict, spcially in trad policy. T saguard claus givs a govrnmnt t mans to try to rsolv tis conlict. T saguard s claus us also sows t irarcy tat inluncs trad policy coics --- altoug satisying political prssurs rom import-compting industris is paramount, t cts o protction on domstic conomic icincy and consumrs is not ignord. W sow tat t rsolution o t objctivs conlict troug t saguard mcanism is undrcut wit asymmtric inormation about costs and adjustmnt ort sinc it rsults in undr-adjustmnt o ig-cost industris and tus maks t saguard claus inicint. 2

3 T institutional justiication or t saguard claus can b ound in Articl XIX o t GATT. 1 Undr tis arrangmnt, r-stablisd in t WTO systm, a country may rais taris or a priod o up to our yars to rmdy or prvnt srious injury. Undr t nw WTO Saguard Agrmnt, suc a masur may b xtndd only i tr is vidnc tat t industry is adjusting. 2 Tus, t WTO signatoris av rcognizd tat adjustmnt to orign comptition is particularly important to t unctioning o t saguard mcanism. olitical rality and xprinc owvr sow us tat protctd industris sk gnrally to maintain tir "tmporary" protction. Wil lowr costs incras icincy and nc proits, ty also rais t cancs tat protction will b subsquntly lowrd. Tis raiss t so-calld "ratct ct" problm o trad protction --- bcoming mor proitabl today jopardizs utur protction. Tis problm is urtr xacrbatd bcaus it may b diicult or govrnmnts to monitor accuratly ow muc ort as bn xpndd in adjusting to intrnational comptition. Rsarcrs av also pointd out tat govrnmnts av mixd incntivs wn acing a domstic industry asking or protction. A govrnmnt wos objctiv unction includs rdistributionist goals along wit concrns about conomic icincy will ncountr problms in optimal implmntation o a tari policy. Staigr and Tabllini (1987) or xampl study t trad policy coic o a govrnmnt tat cars about incom rdistribution among workrs and acs an import surg in an import-compting sctor. Staigr and Tabllini point out tat t govrnmnt s concrn about incom rdistribution maks a r trad commitmnt not crdibl. Traditional trad tory prdicts tat i t govrnmnt commits to a r trad rgim, workrs lav t import compting sctor i t wag alls suicintly. Howvr, i workrs in t import compting sctor ully anticipat a utur tari (aimd to improv t incom rdistribution by raising t wag in tis sctor), a r trad commitmnt in t ac o alling import prics is not crdibl 3

4 givn t incom rdistribution concrns o policy makrs. Staigr and Tabllini trby raisd a tim-consistncy conlict or policy-makrs arising out o compting political concrns: conomic bnits rom r trad (along wit optimal allocation o labor among sctors) conlict wit t political rturn rom protction (arising out o incom rdistribution troug taris). Tornll (1991) xamins wtr spciic protctionist tools can b usd to liminat t Staigr and Tabllini tim-inconsistncy problm. Invstmnt-contingnt subsidis grantd atr adjustmnt as takn plac but providd bor t adjustmnt procss troug a bailout mcanism can b tailord to rsolv t tim-inconsistncy problm but would b so costly or t industry tat ty rarly would b cosn. Otr works av ocusd on t political motivation or trad protction and its wlar consquncs. T political gnsis o protction masurs as bn xamind by Hillman (1982) and urtr dvlopd by Cassing and Hillman (1986), van Long and Vousdn (1991), Brainard and Vrdir (1994, 1997), and Grossman and Hlpman (1994) among otrs. 3 A rqunt point o tis litratur is tat political goals (itr maximizing political support or maximizing t canc or rlction) ratr tan conomic concrns may gnrat motivs or protction. Brainard and Vrdir (1997) sow t inctivnss o adjustmnt goals in a dynamic ramwork. rotction coms rom t intrinsic inconsistncy wn policy makr's dcisions ar politically biasd. T domstic industry uss rsourcs to lobby instad o using ts rsourcs to inanc its adjustmnt activitis. Bcaus currnt adjustmnt is not undrtakn, utur potntial protction brings igr gains to t import-compting industry and tus bcoms mor proitabl compard wit utur adjustmnt. Onc initial protction as bn triggrd, undr-adjustmnt may prsist until t industry inally collapss as is as bn sown in t static ramwork o Cassing and Hillman (1986). 4

5 Tis undr-adjustmnt problm is spcially rlvant wit t saguard claus sinc it is xplicitly dsignd to lp industris rspond to incrasd import comptition. 4 In t saguard institutional ramwork, t govrnmnt wic implmnts t protction acs a dilmma --- t govrnmnt must simultanously provid protction rom orign imports and induc t industry to adopt an optimal lvl o adjustmnt. As Jackson (1993, pp ) points out: "[I] adjustmnt truly is t rational or tmporary saguard actions to limit imports, tn it ollows tat it migt b appropriat or t govrnmnt to dmand an ctiv adjustmnt program rom t industry concrnd, and/or to tailor govrnmnt policis (including dirct or tax aids) to ncourag and assist suc adjustmnt." Tus, a saguard policy sould b basd on a contractual rlationsip: t domstic industry tat bnits rom trad protction as obligations to adjustmnt. In tis papr, w analyz a saguard mcanism wit costly adjustmnt wn trad policy dcisions ar motivatd by bot conomic and political cts. W build on Staigr and Tabllini's work and assum tat t govrnmnt knows tat it acs stratgic bavior by t importcompting industry. W also ollow t spirit o Grossman and Hlpman (1994), among otrs, by allowing t govrnmnt to maximiz a wigtd avrag o domstic consumr and producr groups. In our ramwork, i t industry knows tat t govrnmnt uss protction to aciv political objctivs, it will try to manipulat t protction procss in ordr to gt mor protction tan optimal rom t govrnmnt s point o viw. Wit complt inormation, t industry cannot bav stratgically. T govrnmnt sts t saguard tari suc tat t industry's protction-gnratd proit just quals its adjustmnt cost wil t optimal lvl o adjustmnt ort is suc tat t marginal incras o t adjustmnt cost quals t marginal incras o proit. Tis outcom acivs t igst possibl 5

6 consumr surplus consistnt wit a nwly-comptitiv domstic industry. T complt inormation bncmark allows t govrnmnt to comput t wigt assignd to t prssur group in t asymmtric inormation contxt. T wigt is t political sadow pric associatd wit t constraint o non-ngativ domstic industry proits in t complt inormation contxt. I t irm as an unobsrvabl cost structur and adjustmnt ort, t govrnmnt is abl only to obsrv t ralization o t domstic industry s post-protction proits. 5 T industry will us t paramtrs o t govrnmnt protction dcision to maximiz its protction rnt. I t industry as low costs, tn it as an incntiv to misrport its cost structur to obtain a igr tari bcaus it knows tat a ig-cost industry nds t ig protction to inanc its adjustmnt ort. In tis contxt, t protctd industry acts stratgically as a Stacklbrg ladr vis-à-vis t govrnmnt. Bcaus suc stratgic bavior lowrs govrnmnt wlar troug t burdn placd on consumrs, t govrnmnt must try to rvrs t rols in tat gam by using an incntivcompatibl saguard mcanism. Tis protction scm is implmntd by using a govrnmntproposd implicit contract tat stipulats tat protction is maintaind i t protctd industris bcom proitabl. Howvr, t saguard tari ails to ully rsolv t conlicts btwn consumr and producr intrsts sinc sub-optimal adjustmnt will tak plac undr asymmtric inormation. 6 T papr is organizd as ollows. In Sction 2, w introduc t modl, analyz a complt inormation witout domstic industry stratgic bavior, and comput t wigt assignd to t protction rnt o t prssur group in t asymmtric inormation contxt. In Sction 3, w driv t optimal incntiv-compatibl implicit protction contract proposd by t govrnmnt to t domstic industry wn t lattr bavs stratgically in t contxt o 6

7 asymmtric inormation. Concluding rmarks ar containd in Sction Evaluating t political objctivs conlict wit ull inormation. In tis sction, w valuat t political objctivs conlict wit ull inormation. Wn stting t lvl o protction, w assum tat t govrnmnt must considr t impact on two distinct ntitis: consumrs and import-compting irms. T govrnmnt wants to rciv t igst possibl political rturn rom protcting an industry armd by imports but also sks to minimiz t advrs consumr ct gnratd by protction. Ts two objctivs ar antagonistic but tr xists a irarcy btwn tm. In particular, wil w assum tat t govrnmnt considrs t ct o its trad policy dcision on bot groups, t govrnmnt is assumd to oprat wit t undrlying constraint tat t industry must av a minimum lvl o proits. To aciv its goal, t govrnmnt tis political protction cts to wlar cts. A simpl way to bnit rom t political rturn o protction wil minimizing its political cost (givn by t advrs consumr ct) is to transr t rsponsibility o protction to t importcompting industry. By oring an implicit contract to t protctd industry, t govrnmnt asks it to xrt ort to adapt to orign comptition. Our partial quilibrium ramwork ollows t tory o incntivs in rgulation and procurmnt dvlopd by Laont and Tirol (1993). Tr ar two groups o individuals in t domstic conomy. T prrncs o t ownrs o t import-compting irms ar rprsntd by U, wic quals industry (tari-distortd) rnt. T prrncs o domstic consumrs ar summarizd using an aggrgat utility unction dnotd by V. Total domstic utility unction dnotd by W = U + V. T prctly-comptitiv domstic industry producs a omognous product or t 7

8 domstic markt and is composd o idntical irms, ac o wic as a sunk cost and incrasing marginal cost. W assum tat t sunk cost is suicintly ig to prvnt t ntry o nw domstic irms vn in t prsnc o positiv conomic proits. T conomy is small in intrnational markts so tat orign supply is assumd to b ininitly lastic at t world pric. W also assum tat at tis pric t domstic industry as ngativ proits and tus surs rom srious injury, i.., it ulills t rquirmnts or protction undr t WTO saguard systm. Witout any govrnmnt intrvntion, t domstic industry will considr wtr costly adjustmnt to t orign comptition is in its conomic intrsts. For som rang o domstic cost structurs, costly adjustmnt undr r-trad will maks sns; otrwis, t industry will sut down, trby transrring rsourcs to otr uss and also saving any potntial adjustmnt orts. Howvr, in tis modl, w assum tat political considrations prclud t govrnmnt rom allowing t domstic industry to rciv ngativ proits. Tus, t govrnmnt must implicitly dtrmin a nw domstic pric by imposing a tari troug t saguard claus. 7 W lt ( ) Q dnot t total dmand on t domstic markt. T domstic (tariinclusiv) pric is. T domstic industry supply is givn by q ( ) wil q ( ) rprsnts t domstic xcss dmand or imports. T domstic markt claring condition rquirs tat Q( ) = q ( ) + q ( ). T domstic industry's post-protction proit π ( q ), is a unction o t domstic industry cost typ, t domstic supply q ( ), and t lvl o adjustmnt ort. T adjustmnt cost ( ) K is an incrasing and convx unction o t adjustmnt ort. For simplicity, w assum tat π ( q ), and t adjustmnt cost K( ) ar sparabl. 8

9 Domstic industry rnt U arising rom t saguard policy is dind as t dirnc btwn its tari-distortd proit and t adjustmnt cost incurrd during t protction priod to lowr its production costs: T valu o π ( q ) ( ) ( ) U = π q, K (1), quals post-adjustmnt quantity supplid multiplid by t dirnc btwn t marginal cost (qual to domstic pric or ts prct comptitors) and t avrag total cost: [ ] (, ) (, ) (, ) π q = MC q AC q q (2) W mak t ollowing assumptions about t natur o t proit unction: π > 0, π > 0, π > 0, π < 0, π < 0, π 0, π > 0 (3) q qq q Tus, t domstic industry proit is an incrasing and convx unction o its supply q ( ), an incrasing and concav unction o its adjustmnt ort, and a dcrasing and convx unction o its cost paramtr. In addition, igr ort incrass marginal proit. T consumrs utility unction is givn by t sum o consumr surplus and t rdistributd tari rvnu, wr w is t intrnational pric: V = Q z dz + q ( ) ( ) ( ) (4) T govrnmnt maximizs total domstic utility W wic includs bot consumr and irm wlar. Howvr, t govrnmnt also oprats undr a political constraint. Similar to Staigr and Tabllini (1987), t govrnmnt slcts policis so tat proits ar non-ngativ atr protction. Onc implmntd, protction rmains in ordr to kp uncangd t subsqunt import compting industry ownrs' rnt. In tis cas, t industry will xrt an adjustmnt ort i it is compnsatd by a positiv proit rsulting rom t saguard protction. Tus, W is w 9

10 maximizd subjct to: ( q ) K( ) B( ) π, (5) wr ( ) B is a givn valu assignd to t protction rnt by t govrnmnt. Bcaus adjustmnt ort is inancd by import protction and tat ort is obsrvd by t policy-makr during t adjustmnt priod, t industry is bttr o adopting t rquird lvl o ort wn t govrnmnt commits not to xpropriat t rnt o t irm atr ort as takn plac. I t govrnmnt dos not mak tis commitmnt, t adjustmnt program is not individually rational. T industry will only participat in t program i it is bttr o atr its adjustmnt sinc it knows tat t govrnmnt may gain politically in t adjustmnt procss. In otr words, t gam must b positiv-sum --- t govrnmnt gains politically by inducing t industry to adjust but must sar tat gain in ordr to obtain its coopration. In ordr to maximiz t wlar unction W, t govrnmnt will inanc t industry s optimal adjustmnt ort * by raising t markt pric () wit a tari t(), bot o wic ar unctions o t domstic irm s costs. Wit no iddn action or inormation o t industry, t govrnmnt obsrvs t world pric w, t domstic industry cost typ, t proit π ( q ) and t adjustmnt cost ( ) K. T govrnmnt political coic mrgs rom t solution o t program (1):,, ( 1) Max W = Q, s. t. π ( z) dz + π ( q, ) K( ) + ( ) q ( ) ( q, ) K( ) B( ) w (6) T Lagrangian L associatd wit (1) is: 10

11 Max L = Max Q( z) dz + ( w ) q ( ) + ( + λ) [ π( q, ) K( ) ] λ B( ),, λ,, λ 1 (7) wr λ is t Lagrangian multiplir or t non-ngativ proit constraint T govrnmnt s problm can b sn as maximizing a wigtd avrag o domstic intrsts. In particular, i t constraint is binding (i.., irms mak ngativ proits at world prics), tn λ is positiv and t domstic industry proit rcivs a igr wigt tan domstic consumrs. T solution to (1) rsults in t implicit contract in t complt inormation cas (givn by t valus o *, *, t CI ) and must satisy t ollowing (S Appndix 1 or dtails.): π ( q ( ) ) K( ) *, * = * (8) π ( q ( * ), * ) = K ( * ) (9) t CI q = * w = λ (10) q Ts solutions av asy intrprtations. Exprssion (8) mans tat t pric on t domstic markt as to b raisd so tat t rnt o t protctd industry quals zro. Tis rsults in t lowst possibl pric on consumrs consistnt wit non-ngativ industry proit, i.., B() = 0. Exprssion (9) mans tat adjustmnt is cosn optimally rom t industry s viw --- t marginal ct o adjustmnt ort on proit must qual its marginal cost. Exprssion (10) is t complt inormation tari. It will dpnd on t pric ct on domstic xcss dmand and λ, t political sadow cost o t non-ngativ proit constraint. Exprssion (10) can b rarrangd to sow ow λ, t political sadow cost o protction rlcts 11

12 t incras o ovrall wlar i t tari was lowrd. It allows us to valuat t acutnss o t political objctivs conlict btwn consumrs and producrs, as masurd by t wigt tat t govrnmnt givs to t domstic industry wn stting its trad policy: ( w *) η ε λ ( w *) = = β (10 ) * * ξ q q q q wr β = ξ = η = ε =,,, (11) q q q q Exprssion (10 ) sows tat λ, t political sadow cost o protction can b brokn into two distinct cts: a pric ct and an lasticity and markt sar ct. First, bot vrsions o (10 ) contain ( w *)/* wic is simply t prcntag drop in t domstic pric i t taris wr rmovd. In otr words, it is t dirct opportunity cost o t pric distortion. T lowr (igr) is t world (tari-distortd) pric, t igr sadow pric o protction. T scond st o lmnts involvs pric lasticitis and markt sar cts. T irst vrsion sows tat t mor lastic import dmand η is, t igr will b t political sadow pric. Convrsly, t lowr t domstic markt sar q /q, t largr λ will b. T scond vrsion sows tat domstic rspons to pric cangs and orign supply cangs ar also important. In particular, a ig valu or domstic pric lasticity ε translats into a ig valu or λ as dos a larg incras in domstic supply as imports all. As sown abov, as long as t govrnmnt can obsrv and t unction π ( q ) can inr ort. Tror, in ordr to minimiz t conomic cost o t protction, t govrnmnt can impos a "minimum proit valu targt" or t domstic industry, π ( q ),, it, *. I t industry dos not xrt t optimal lvl o adjustmnt ort, it as not rspctd t 12

13 implicit contract. T govrnmnt as to pnaliz it at t nd o t protction priod, onc t political rturn as bn arnd, by lowring t tari blow its post-protction commitmnt valu. Howvr, t ability to monitor prctly mans tat t govrnmnt nvr pnalizs bcaus its trat is crdibl. 3. Using t saguard claus undr asymmtric inormation. Wn t govrnmnt is unabl to obsrv domstic production costs, it cannot disntangl t cts o ig domstic production costs and low adjustmnt ort. Low ralizd proits could b t rsult o a ig-cost industry wic ad xrtd optimal adjustmnt ort or it could b a consqunc o a low-cost industry undr-adjusting. Tus, t domstic industry as an incntiv to manipulat t protction scm sinc it knows tat t govrnmnt sks to maximiz its political rturn. T industry may do so by announcing tat it is a ig-cost industry in ordr to obtain a protction lvl xcssiv or its tru costs. Ts acts igligt t principal-agnt rlationsip btwn t govrnmnt and t domstic industry wic can b viwd as a Stacklbrg gam wr t industry is t ladr and t govrnmnt is t ollowr. T purpos o t optimal political coic undr stratgic bavior consists o rvrsing t rols in t gam. By proposing a politically-optimal incntiv-compatibl mcanism to t domstic industry, t govrnmnt rsolvs bot unobsrvabl ort and advrs slction problms arising out o t dsir to implmnt t complt inormation policy in a world o incomplt inormation. T inormation asymmtris man tat t govrnmnt cannot cck t tru lvl o proits. Tror wn t injurd industry asks or protction, t govrnmnt proposs an implicit contract to t domstic industry. T contract spciis t politically optimal markt 13

14 pric (and accordingly t saguard tari) and t lvl o proit tat t domstic industry commits to arn in xcang or t protction. At t bginning o t protction pisod, t proit is subjct to uncrtainty so t protction cannot b dirctly basd on ( ) π.. Instad, t govrnmnt obsrvs a noisy ralizd lvl o proit but dos not know t tru valu o and cannot monitor t lvl o adjustmnt ort,. In otr words, t govrnmnt bass protction on an obsrvabl and vriiabl x-post monitor x subjct to t conditional probability distribution F( x π ) wit dnsity (.). T govrnmnt s xpctations about ar summarizd by a prior cumulativ distribution + G( ) wit dirntiabl dnsity g(), suc tat g() > 0 or all blonging to t st Θ = [ -, ] and suc tat G/g as t monoton azard-rat proprty, i.., is non-dcrasing in. T distribution unction G is common knowldg to all playrs. In ordr to induc t domstic industry to coos t tari dsignd or it and to xrt t optimal lvl o ort, t autority proposs t contract { π ( ), ( )} tat links t typ industry s coic o t domstic markt pric ( ) to t proit π ( ). 3.1 Constraints on t govrnmnt problm wit asymmtric inormation. 3.1.a olitically incntiv-compatibility (IC) constraint. T protction rnt B o t domstic industry o typ wn it rports ~ is: ( ) (12) ~ ~ B, x, q x dx K ( ) = ( ) ( π ) ( ) x By applying t Rvlation rincipl 8, t govrnmnt can rstrict its political coic to incntiv-compatibl mcanisms, i.., mcanisms or wic t industry rports its typ ~ trutully. In tis ramwork, t typ industry will coos a rspons ( ) = i its protction 14

15 rnt B(, ) is at last as ig as its rnt rom lying B ( ~, ). Formally, t mcanism is politically incntiv-compatibl (IC) i: ~ ~ B, B,,,, IC + + ( ) ( ) ( ) [ ] [ ] ( ) (13) Using t wll-known and usul trick o Mirrls (1971), IC can b rwrittn as ollows: ~ B( ) = max x(, q ) ( x ) dx K( ( ) π ) (14) ~ x Exprssion (14) can b usd along wit Libniz s rul and t nvlop torm to obtain: db( ) ~ ~ = x(, q ) π ( x π ) π dx = π x(, q ) π ( x π ) dx (15) d x T optimal adjustmnt lvl () or t industry is givn by: ( ) arg max B( ) (16) Rstricting ourslvs to t irst-ordr-condition approac (s Rogrson, 1985) or a solution to (16) yilds: db( ) ~ = (, ) ( π ) π ( ) = d x x q π x dx K( ) 0 (17) x By rarranging xprssion (17), w gt a mor tractabl xprssion: Substituting (17 ) into (15) yilds: K ( ) ~ = x(, q ) π ( x π ) dx (17 ) π x db d ( ) π = K 0 (18) π Exprssion (18) tus incorporats bot an incntiv-compatibility constraint and t condition tat adjustmnt ort is cosn by t industry to maximiz its own protction rnt. T inquality o (18) mans tat IC protction rnt arising rom t saguard policy must b a 15

16 dcrasing unction o t industry s cost typ. Tis ariss bcaus proit nt o adjustmnt costs is a positiv and ngativ unction o ort and cost typ, rspctivly (π > 0 and π < 0), and adjustmnt costs ris wit ort K > 0. I tis irst-ordr condition is satisid and i π() is non-incrasing in, tn ts conditions ar suicint or t global politically incntiv- compatibility o t govrnmnt political coic mcanism. (S Appndix 2 or IC scond- ordr condition tratmnt). 3.1.b. Non-ngativ proits or all industry cost typs. Wn stting t saguard policy, t domstic govrnmnt as to considr its political objctiv, i.., t political rturn maximization problm wic rquirs tat t domstic industry s protction rnt must b non-ngativ watvr its cost typ. W dnot tis constraint by (R) wic is an individual rationality constraint --- unlss irms aciv at last a sar o t surplus accordd to t govrnmnt troug t politically-optimal protction program, it will not participat in t plan. Formally, w av: Intgrating t IC constraint, w gt: B( ) 0 Θ ( R) (19) ( ) + dk ( ν ) π + B( ) = dν + B( ) (20) d π Sinc w know rom (18) tat ( ) B is a dcrasing unction o t industry cost typ or any IC mcanism, (R) can b rplacd by: ( ) B( ) B + = 0, 0 + (21) tat is, only t igst cost irm will rciv no rnt rom protction. T inormational rnt 16

17 arising out o t incomplt inormation is tus: ( ) + dk ( ν ) π B( ) = dν (20 ) d π 3.2 T govrnmnt s problm undr asymmtric inormation. T privatly-ld inormation will act t industry s protction rnt B and tror cang t govrnmnt coic o a tari. T govrnmnt potntially can us t provision o t rnt to induc t industry to act in a way wic minimizs t political costs o incrasd prics to consumrs. Undr asymmtric inormation, t govrnmnt knows tat t domstic industry will bav stratgically. Tus, t govrnmnt also will tak t IC and t R constraints into account wn maximizing t xpctd valu o t wigtd-avrag national wlar unction (W AI ). Formally: ( 2) + AI Max W g( ) d (.), (.) db( ) dk( ) π st: = d d π B ( IC) + ( ) = 0 ( R) (22) wr W AI is t Lagrangian unction rom t complt inormation problm. Tat is: AI W = V + ( 1 + λ ) U λ B( ) (23) Exprssion (23) maks clar t domstic conlicts acing t govrnmnt. For positiv valus o λ, t producrs rciv a igr wigt tan consumrs. At t sam tim, t inormation asymmtris man tat B() will b gratr tan zro or all but t last icint 17

18 industry typs. But t govrnmnt must b willing to or som positiv rnt to induc good adjustmnt bavior wic will rduc t valu o t govrnmnt s objctiv unction. T govrnmnt, aving a prior bli about t domstic industry cost typ summarizd by t dnsity g(), sks to implmnt its political coic subjct to t political incntivcompatibility and t political rturn constraint. W adopt a control-tortic approac to solv t govrnmnt's problm. 9 In tis approac, t industry's protction rnt B() is t stat variabl and t controls ar, and db()/d). Exprssion (20 ) and t irst-ordr conditions yild (s Appndix 3 or dtails): + π π ( q ( ) ) ( ( )) ( ( ν ), K = K ) dν (24) π π 1+ λ π K g = λ G π ( ) ( ) ( ) ( ) π K K (25) π ( ) * ( ) ( ) w β 1 π = = + G λ K * * η q π g t (26) Ts rsults sow tr typs o distortions du to t stratgic bavior o prssur groups. Exprssion (24) dmonstrats t political rturn distortion. T govrnmnt must incras t protction rnt B o all industris wit lss tan maximum costs ( < + ) i it wants t political rturn constraint (R) not to b violatd. Tis mans tat nsuring a non-ngativ protction rnt to t igst-cost irm will allow otr irms to obtain inormational rnts in addition to protction rnts. T inormational rnt is at its maximum or t lowst-cost industry ( = ) and quals zro or t igst-cost industry ( = + ). Exprssion (25) sows an ort distortion. T trm on t LHS o (24) is t xpctd 18

19 marginal political rturn o t adjustmnt program, i.., t incras in domstic proit du to ort, valuatd at t industry wigt in t govrnmnt s problm ( 1+ λ ). T RHS is t xpctd incrasd cost o t inormational rnt as ort riss. (Rcall tat µ ( ) = λ G ( ) is t co-stat variabl associatd wit t stat quation IC in t Hamiltonian.) Tus, t govrnmnt inducs t industry to incras its adjustmnt ort until t xpctd marginal proit quals t conomic cost o t inormational rnt. Tis yilds an optimal lvl o ort only or t low cost industry. For tat industry, t lvl o adjustmnt ort is t sam as in t symmtric inormation stup. For all otr industris, t lvl o adjustmnt ort is lowr tan wit symmtric inormation. T coic o protction undr asymmtric inormation tror yilds lowr ort or t ig-cost industris. Tis act rlcts t trad-o acd by t govrnmnt btwn assisting t adjustmnt ort (incrasing t political rturn) and rducing t domstic industris' inormational rnt (dcrasing t conomic cost). On on and, t govrnmnt is orcd to lav rnts to t industry to induc it to adopt an optimal adjustmnt ort. On t otr and, it wants to rduc t bnits tat ar costly or consumrs troug ig domstic prics. Ts rsults allow us to giv t ollowing proposition: roposition 1: Undr stratgic industry bavior, t political coic o trad protction troug t saguard claus ntails a trad-o btwn maximizing political rturn and minimizing conomic costs. Tis trad-o cts a sub-optimal lvl o adjustmnt ort: lss icint industris undr-adjust wil only t most icint adjusts optimally. T saguard claus tror is conomically irrational. 19

20 T ct o asymmtric inormation on t lvl o t tari compard to complt inormation is ambiguous and dpnds on t cts o rducd imports on t proit trad-o btwn ort and cost typ. In particular, xprssions (10) and (26) sows tat t dirnc btwn t complt and incomplt inormation lvl o taris quals: 1 G( ) K g( ) ( π / π ) q T sign o (26) dpnds on t valu o ( π π / ) q (27), wic is ow canging domstic xcss dmand or imports q acts t marginal rat o substitution btwn ort and cost typ or a constant lvl o proits. I ( π π / ) q > 0, tn or a givn lvl o proits, a li about costs will rsult in lowr adjustmnt ort. Howvr, wil t tari will b igr, t ( ) + dk ( ν ) π inormational rnt, B( ) = dν, will also b adjustd downward. d π Tis yilds t ollowing proposition: roposition 2: I a rduction in imports rducs (incrass) t trad-o btwn ort and cost typ, an incomplt inormation saguard tari will b igr (lowr) tan t complt inormation tari. T govrnmnt consquntly adjusts t inormational rnt downward (upward). Stratgic bavior tus rducs (incrass) consumr wlar at t cost o sub-optimal adjustmnt ort o inicint industris. Wn t domstic industry adopts stratgic bavior, t autority dos not tak into account t ral protction rnt but considrs a "virtual protction rnt" wic includs t 20

21 inormational part o t protction rnt. T conjunction o asymmtric inormation and dirnt industry cost structurs rsults in a ngativ inormational xtrnality --- t prsnc o ig-cost industris causs t low-cost industris to bav stratgically. In ordr to intrnaliz tat inormational xtrnality gnratd by t prsnc o ig-cost industris, t autority distorts t symmtric inormation saguard policy o ig-cost industris and inducs tm to adopt a sub-optimal lvl o adjustmnt ort. 4. Concluding rmarks. In tis papr, w av sd som ligt on govrnmnt us o t saguard claus. W av modld t saguard claus as a dvic usd by govrnmnts to rsolv political objctivs conlicts arising rom t tnsion btwn maintaining non-ngativ domstic industry proits and t impact on consumrs o igr taris. W av don so in a modl wr t domstic irm incurs costs as it adjusts to orign comptition. T govrnmnt s policy is politically constraind by a rquirmnt tat domstic irms arn non-ngativ proits. W ound tat i t govrnmnt can monitor ort and costs prctly, t govrnmnt can or a tari in xcang or an adjustmnt ort optimal or t domstic industry s spciic cost structur. Complt inormation and t lack o stratgic bavior by t domstic industry allows t govrnmnt to or only noug protction to insur tat t industry will adjust but tat simultanously minimizs consumr costs. Ts consumr costs will b rlativly small wn domstic production xpands rlativly mor tan t domstic consumption contracts. W also av studid ow a govrnmnt migt try to implmnt a protction plan wn t problm o t objctivs conlict is urtr complicatd by asymmtric inormation. W av assumd tat t govrnmnt is imprctly inormd about t domstic industry's aturs. 21

22 Spciically, t govrnmnt is abl to cck t domstic industry s proit lvl at t nd o t protction priod but is unabl to disntangl t cts o dirnt irm cost typs rom irm ort to incras icincy. W sowd tat in suc an nvironmnt, t domstic industry acts stratgically so tat a (constraind) optimal protction rul must b drivd wic is incntiv-compatibl. T rsulting incntiv mcanism consists o a mnu o implicit contracts proposd by t govrnmnt to t domstic industry wn t saguard policy is rqustd. T implicit contract wic implmnts t politically-optimal tari coic (i.., t coic tat rsolvs t political objctivs conlicts among dirnt domstic intrsts), rsults in a ig-cost industry rmaining inicint. T only industry wic would adopt t optimal lvl o adjustmnt, ironically, as t lowst-cost. 10 Tis rsarc rinorcs t argumnt tat t WTO saguard mcanism as wak oundations in pur conomic considrations. T basic contradiction containd in t saguard cod (protcting in ordr to lp adjustmnt) and our rsults suggst tat r trad would b a mor icint adjustmnt program. Witout govrnmnt intrvntion, domstic irms tmslvs would mak t dcision wtr adjustmnt or xit would mak mor sns. Evn toug Articl XIX o t GATT rquirs adjustmnt plans to b part o a saguard mcanism, t rsults prsntd r cast doubt on govrnmnts ability to induc domstic industris to adjust to orign comptition. Wil politicians migt lgitimat saguard mcanisms by appals to adjustmnt, suc programs likly would b implmntd inicintly. Rrncs: Baldwin Robrt E., "T olitical Economy o Trad olicy", Journal o Economic rspctivs 3 (1989): Brainard, S. Lal and Tirry Vrdir, "Lobbying and Adjustmnt in Dclining Industris" 22

23 Europan Economic Rviw 38 (1994): Brainard, S. Lal and Tirry Vrdir, "T olitical Economy o Dclining Industris: Snscnt Industry Collaps Rvisitd" Journal o Intrnational Economics, 42 (1997): Cassing, Jams H. and Ayr L. Hillman, "Siting Comparativ Advantag and Snscnt Industry Collaps" Amrican Economic Rviw, 76 (1986): Dinopoulos, Elias, Tracy Lwis, and David Sappington, Optimal Industrial Targting wit Unknown Larning-by-doing. Journal o Intrnational Economics, 38 (1995): Fnstra, Robrt C. and Tracy Lwis, Distributing t Gains rom Trad wit Incomplt Inormation, Economics and olitics, 3 (1991): Grossman, Gn and Elanan Hlpman, rotction or Sal, Amrican Economic Rviw; 84 (1994): Hillman, Ayr L., "Dclining Industris and olitical-support rotctionist Motivs" Amrican Economic Rviw, 72 (1982): Hillman, Ayr L., T olitical Economy o rotction, Cur, Switzrland:. Harwood Acadmic ublisrs, Jackson, Jon H., "Saguard and Adjustmnt olicis," in Robrt M. Strn, (d.), T Multilatral Trading Systm: Analysis and Options or Cang, Ann Arbor: Univrsity o Micigan rss, Laont, Jan-Jacqus and Jan Tirol, A Tory o Incntivs in rocurmnt and Rgulation, Cambridg, MA: MIT rss, 1993,. Mirrls, Jams, "An xploration in t tory o optimum incom taxation", Rviw o Economic Studis, 38 (1971), Moor, Mical O., "Nw Dvlopmnts in t olitical Economy o rotction," in Colin Cartr, Alx McCalla and Jrry Sarpls (ds.), Imprct Comptition and olitical Economy, Bouldr, CO: Wstviw rss, Moor, Mical O. and Stvn Suranovic, "A Wlar Comparison Btwn VERs and Taris 23

24 Undr t GATT," Canadian Journal o Economics, 26 (1993): Myrson, Rogr B., "Incntiv Compatibility and t Bargaining roblm", Economtrica, 47 (1979): Nlson Douglas, "Endognous Tari Tory: A Critical Survy", Amrican Journal o olitical Scinc, 32 (1988): Rodrik Dani,, "olitical Economy o Trad olicy" in Gn M. Grossman and Knnt Rogo (ds.), Handbook o Intrnational Economics, Vol.3, Amstrdam: Elsvir Scinc ublisrs, Rogrson, William, "T First Ordr Approac to rincipal-agnt roblms", Economtrica, 53 (1985): Staigr Robrt W. and Guido Tabllini, "Discrtionary Trad olicy and Excssiv rotction", Amrican Economic Rviw, 77 (1987): Tornll, Aaron, 1991, "On t Inctivnss o Mad-to-Masur rotctionist rograms", in Elanan Hlpman and Assa Razin, (ds.), Intrnational Trad And Trad olicy, Cambridg, MA: MIT rss. Uruguay Round Agrmnt on Saguards ttp:// Marc Van Long, Ngo and Nil Vousdn, "rotctionist Rspons and Dclining Industris" Journal o Intrnational Economics, 30 (1991):

25 Appndix 1: Saguard tari wit symmtric inormation: T domstic govrnmnt maximizs t sum o consumr surplus, domstic proit nt o adjustmnt costs, and tari rvnu: Max W, s. t. π = Q ( z) dz + π ( q, ) K( ) + ( ) q ( ) ( q, ) K( ) B( ) ( λ) w (A1a) W can rwrit (A1a) as ollows: Max ( ) ( ) ( ( ) ( )) ( ) ( ) ( ) L Max = Q z dz + 1+ λ π q, K + w q λ B,, λ,, λ Consumr surplus will b igst wil maintaining non-ngativ domstic proits wn ( ) B = 0. First-ordr conditions yild: L = 0 K ( ) π q ( ) * = *, * ( ) L = 0 K( * ) = π * q ( ) *, * λ ( ) ( q, ) L q ( ) ( λ) π = 0 w = q 1+ [ ] Bcaus π (, ) (, ) (, ) q = MC q AC q q w can rwrit (A1d) as: ( ) q ( 1 λ) (, ) q MC q w = + q q q (A1b) (A1c) (A1d) (A1) Bcaus ac irm is a pric-takr, w av: MC q (, ) q Substituting (A1) into (A1) yilds t optimal complt inormation tari: q = 1 (A1) 25

26 26 t q q CI w = = λ (A1g) Dividing by t optimal domstic pric * and rarranging yilds t valu o t political sadow pric on t domstic proit constraint: ξ ε β η λ = = * *) ( * *) ( w w (A1) Wit: β ξ η ε = = = = q q q q q q q q,,,

27 Appndix 2: Scond-ordr conditions or incntiv-compatibility wit asymmtric inormation: ( ) Lt ( ) =, π ( ), q ( ) b t ort ndd to arn a proit π ( ) wn t supply is q ( ) and assum tat: > 0, > 0, < 0, < 0, < 0, π q π q Assum tat t industry is lying about its cost typ. In tis cas, its ort will b: ( ) ~ ~ ~ (, ) =, π ( ), q ( ) wr ~ is t dgr o t li. In tis cas, t rnt rom lying is: Trut-tlling implis: B ~ ( ) B ~~ ( ) ( ( )) ~ ~ ~ ~ (, ) π ( ), π ( ), ( ) B = K q (A2a) ~, = 0 ~,, < 0 wic is quivalnt to: B ~, = 0 ~,, > 0 (A2b) ( ) B ( ) ~ ~ ~, ~, ~, bcaus db ~ ( ) = 0 = B ~~ ( ) + B ~ ( ) ~, > 0: Lt us sow tat B ~ ( ) ~ ~ ~ ~ (, ) & ( ), ( ), ( ) d ~ ~ ( ( )) ~ (, π ( ), q ( )) B ~ = π K π q (A2c) d ~ B ( ) K d π ~, = + d dq d dπ K d + dq d π q π q (A2d) W av B ~ ( ) ~, > 0 i dq ( ) > 0. T domstic supply as to b a incrasing unction o t cost typ d wn t adjustmnt program taks plac or t scond-ordr conditions to b satisid. Tis will b t cas i t tari is an incrasing unction o t cost typ. 27

28 ( ) ( ) Appndix 3: Saguard tari wit asymmtric inormation T govrnmnt s problm wit asymmtric inormation will b: + Max E ( W) = Max ,..,. ( ) ( ) ( ) ( ) ( ) ( ) ( ) Q( z) dz ( 1 λ) π( q, ) K( ) w q λ B g d subjct to: db d ( ) π = K 0 (IC) π + + ( ) = ( ) > [ ] B 0 and B 0 or, (R) T Lagrangian associatd wit t maximization problm is: Qz L= + µ ( ) dz+ ( 1+ λ) ( π( q, ) K( ) ) + ( ) q ( ) λ B( ) g( ) π π ( ) K + µ &( ) B( ) w d µ + + ( ) B( ) (A3a) wr ( ) µ is t co-stat variabl associatd wit t stat quation (IC). Lt H b t Hamiltonian associatd wit t Lagrangian L. (,,, µ, ) H B By rwriting L, w obtain: Q z dz q K = 1 + ( w ) q ( ) λ B( ) ( ) ( ) + ( + λ) π(, ) ( ) dk( ) π g( ) + µ ( ) d π (A3b) ( ) + + [ (,,,, ) &( ) ( )] ( ) ( ) L = H B µ + µ B d µ B (A3c) Lt γ ( ) = ( ), ( ) b t control vctor. A ncssary condition or L to b a maximum is tat t cang in L vaniss: 28

29 + H H dl = d γ + + µ & B µ γ T cang in t valu o L vanis i: + + ( ) db( ) d ( ) db( ) H H = 0 = = 0 = 0 B, µ & ( ), µ ( + ) B( + ), µ ( ) bcaus t trminal valu B( ) is r. Tis yilds t ncssary conditions or optimality: ( ) H ( ) ( λ) π q, π = q q ( ) µ ( ) ( ) + w + + g K ( ) + ' 1 = 0 ( ) π H ( ) π = µ π π K K λ ( π q K ) g( ) + π + 1+, = 0 ( ) ( ) ( ) ( ) H = µ & ( ) = λ g( ) B( ) Using t transvrsality condition, ( ) Tis yilds: µ = 0, w gt µ ( ) = λ G( ) π 1+ λ ( π ) ( ) = ( ) q, K g λ G π ( ) ( ) ( ) + π K K π (A3d) * * w K = λ β 1 + π η q π G( ) g( ) (A3) 29

30 Endnots 1 Similar saguard clauss can b ound in prrntial trading agrmnts suc as NAFTA and Mrcosur. 2 Articl VII o t Uruguay Round Agrmnt on Saguards (1994). 3 S Baldwin (1989), Bagwati (1988), Hillman (1989), Moor (1990), Nlson (1988), and Rodrik (1995) or survys o t ndognous protction litratur and industry rspons to import comptition. 4 Tis is in contrast to otr masurs suc as antidumping and countrvailing duty masurs wic, at last in principl, ar not dsignd to protct domstic industris rom siting comparativ advantag but instad insulat tm rom allgd "unair" trad practics. 5 S Dinopoulos, t al. (1995) or optimal policy wn a irm s larning-by-doing abilitis ar unobsrvabl. 6 Fnstra and Lwis (1991) analyz taris in a pur xcang conomy wn domstic agnts av privat inormation about tir ndowmnts. Ty ind tat i t govrnmnt is constraind by nsuring arto gains rom trad, a non-linar tari structur will rsult. 7 W ignor t compnsation rquird undr t saguard claus as rquird undr Articl XIX o t GATT. S Moor and Suranovic (1993) or a modl wit GATT-consistnt saguard compnsation scms. 8 S Myrson (1979). 9 In tis program, w tak t lvl o ort as t control variabl. Indd, t control variabl is π ( ) but i w assum tat π ( ) = y( ) z( q ) wr t unctions y(.) and z(.)ar obsrvabl, t two approacs ar quivalnt bcaus π(.) can b immdiatly dducd rom t valu o (.) 10 Wil t discussion ocusd on ort to rduc costs dirctly, a rr as pointd out tat it could also b altrd to analyz incntivs or canging a wol rang o conomic activitis acting costs witin an import-compting irm. Ts migt includ work practics, adoption o nw tcnologis, workr training, tc. 30