midterm pol 120

Question 1

Why do countries trade with one another?

Answer 1

Efficiency from specializing; comparative advantage

a. Absolute advantage – costs of producing goods
b. Comparative advantage (Ricardo) – efficiency
gains from specialization
c. Heckscher-Ohlin – abundant and scarce factors
of production. Implications for
supporting/opposing free trade

Question 2

Who are the domestic winners or losers from free trade?

Answer 2

If you have an abundant factor and you are trading, free trade is great

if you have a scarce factor and you are involved in free trade, free trade is terrible

Question 3

Why do countries restrict trade?

Answer 3

To protect domestic groups harmed by free trade; to
provide benefits for politically influential groups.

Question 4

Tariff =

Answer 4

= a tax that is imposed by a government
on imported goods or services.

Question 5

Quota =

Answer 5

Quantitative limit imposed by
government on the amount of a good or
service that may be imported during a period
of time.
(c) Lauren Peritz 2023

Question 6

subsidy=

Answer 6

A sum of money granted by the
government to assist an industry or business
so that the price of a commodity or service
may remain low or competitive.

Question 7

What is the international consequence of a trade
barrier?

Answer 7

If country A has a tariff, it often hurts country B and it can
be inefficient.

Question 8

How is free trade is an international collective action
problem?

Answer 8

Mutual incentive to restrict; collective benefits if everyone
liberalizes trade. Prisoner’s dilemma.
– Solve collective action problem with a free trade TREATY

Question 9

ABSOLUTE advantage

Answer 9

when it can produce a unit of a good with less
labor (or another input) than another country can.

ex US produces 2 computers with $100 inputs
– Brazil produces 1 computer with $100 inputs
– US has an Absolute advantage in producing computers

Question 10

COMPARATIVE advantage

Answer 10

if the opportunity cost
of producing that good in terms of other goods is lower in that country than it is in
other countries.
* Example:
– US produces 2 computers OR 10 pairs of shoes with $100 inputs
– Brazil produces 1 computer OR 10 pairs of shoes with $100 inputs.
– US has comparative advantage in computers: 2 computers:10 shoes = 1:5
– Brazil has comparative advantage in shoes: 1 computer:10 shoes = 1:10

Question 11

Heckscher-Ohlin

Answer 11

A country will have a comparative advantage in, and thus will tend to export, those goods whose production requires the intensive use of the factor of production that that country
has in relative abundance.

Question 12

H-O Implications

Answer 12

What happens if I own the abundant factor of production and my country allows free trade?
– (unskilled) worker in Bangladesh
– Farmer in US

What happens if I own the abundant factor of
production and my country allows free trade?
– (unskilled) worker in Bangladesh
– Farmer in US
* Free trade is GREAT!
– Bangladesh: worker wages go up*
– US: price of cotton goes up

What happens if I own the scarce factor of
production and my country allows free trade?
– (unskilled) worker in US
– Farmer in Bangladesh

What happens if I own the scarce factor of
production and my country allows free trade?
– (unskilled) worker in US
– Farmer in Bangladesh
* Free trade is TERRIBLE!
– US: worker wages go down
– Bangladesh: price of cotton goes down

Owners of abundant factors should promote free
trade.
– Owners of scarce factors should oppose free
trade.

Question 13

Stolper-Samuelson Theorem

Answer 13

in a country that specializes in production of a given
good, the owners of the relatively abundant factor of
production in that country will experience a gain in
their returns and real incomes as a result of trade
liberalization, and the owners of the relatively scarce
factor of production will sustain a drop in their
returns of real incomes

Question 14

International Cooperation Problem

Answer 14

International collective action problem of
FREE TRADE is like the canonical Prisoner’s
Dilemma
1. Collective benefits from cooperating on free trade
2. Individual incentive to “cheat” = restrict trade
+ Uncertainty about what the other country will do

Countries collectively benefit from free trade.
– Mutual gains from specialization according to
comparative advantage
2. A single country can benefit from a trade barrier,
provided all other countries maintain open trade
– Individual countries sometimes want to restrict trade
(e.g. sugar quota helps US)
– Trade barriers by country A hurt country B
* Specifically: hurt foreign producers (e.g. Mexican farmers
who export sugar to US)

Countries are UNCERTAIN about what their
trading partners will do.
* How do they solve this problem? Reduce
uncertainty.
– Create a free trade agreement
* clearly establishes standards
* provides enforcement

Question 15

What are some ways that countries restrict trade?

Answer 15

Trade barriers include tariffs, subsidies and quotas.
* Trade barriers typically benefit a specific set interest
group or industry (e.g. farmers, steel manufacturers

Question 16

Which interest groups are best at getting trade
protection from their government?

Answer 16

Groups that mobilize and act collectively
– Groups that spend money on lobbying

Question 17

Increasing exposure to trade can hurt some groups.
They are likely to mobilize and demand trade
protection.
– Does this lead to class conflict or urban-rural conflict?

Answer 17

Depends on the factor endowments.

Question 18

When developing countries democratize, they are
likely to adopt more liberal trade policies. Why?

Answer 18

Expansion of the selectorate increases demand for trade
liberalization.

Question 19

Many kinds of trade barriers

Answer 19

Tariff
– Production Subsidy
– Import Quota
* Often, trade barriers advantage certain groups (e.g.
farmers, steel manufactures) at the expense of other
groups (e.g. taxpayers, foreign producers).

Question 20

Domestic Collective Action

Answer 20

Public goods
– Non-excludable – goods no one can be prevented
from consuming for free.
* E.g. national defense, law and order, public radio…
lobbying by an interest group
* Free-Rider problem
– Non-excludability creates incentives to “free-ride”
– When people free-ride, the desired good is under-
produced or not produced at all.

Question 21

Solutions to the Free Rider Problem?

Answer 21

Exclusivity: Smaller groups are better at
overcoming free-rider problem.
* Lower organizational costs
* Bigger impact of individual’s contribution
2. Privileged Groups: Some members benefit more
than others.
* Benefits are concentrated so members that gain most may
provide good even if others free ride.
* E.g. oligopolistic (concentrated) industries

Question 22

Collective Action & Demand for Foreign
Economic Policy

Answer 22

Interest group politics
– Government policies that benefit a group do not
differentiate between individuals in that group.
* E.g. tariff of steel imports or a subsidy to sugar growers.
* Political influence
– Explains why producers tend to be organized while
consumers are not.
– Explains why government faces strong pressure for
protection from import-competing industries but
weak pressure from consumers.

Question 23

Preferences + Political Influence à Policy

Answer 23

Domestic winners and losers from trade
– Reflect factors of production
– Generates preferences
* Who has more political influence?
– Group that can better overcome collective action
problems

Question 24

Rogowski (1987)

Answer 24

Q: What are the political effects of increasing
exposure to trade?
* A: Increasing exposure to trade affects
political cleavages (who allies with whom).
The particular cleavages depend on relative
factor abundance.

add rural conflict and class conflict

Question 25

Liberalization of Trade Policy

Answer 25

Why have developing countries adopted more liberal
trade policies?
a. Economic crisis
b. International pressure
c. Political leaders
d. Democratization Milner and Kubota (2005)

Question 26

Liberalization of Trade Policy:
Milner & Kubota’s Explanation

Answer 26

Democratization
i. Transition to democracy means previously disenfranchised groups
become voters
ii. These new groups of voters benefit from trade liberalization
iii. Political leaders need support so they liberalize trade policy to
ensure survival

Question 27

Could some other thing be causing both
democratization and trade liberalization?
* What prompted democratization in the first place

Answer 27

Economic crisis
– International pressure
– Ideology

Question 28

International Investment

Answer 28

Bilateral investment treaties, credible
commitment
B. expropriation risk in democracy v. autocracy
C. and trade

Question 29

incentives: Why do “host” countries sign
bilateral investment treaties? Why do “home”
countries sign bilateral investment treaties?

Answer 29

bring in jobs & money, Sending governments (investors’ home country) sign BITS to help
corporations based within their borders
-tax revenue & prevent capital flight

Question 30

what is expropriation ?

Answer 30

Expropriation occurs when a public
government agency takes private property for a purpose deemed to be in the public interest

private property can be owned by both entities both within and outside the country

Risk of expropriation deters foreign investors example Cuba confiscated property from US companies

Question 31

Bilateral investment treaties are commitments
to provide a safe investment environment.
– Why is the commitment credible?
* Why is foreign direct investment at risk of
expropriation?

Answer 31

bilateral investment treaties - International agreements between
countries that establish terms and conditions for private investment by nationals and companies of one country in the jurisdiction of another.

What do BITs cover?
* Expropriation
* Legal treatment
* FDI admission
* Settlement of disputes

Question 32

What are some features that make a “host”
country a safe environment for foreign direct
investments (FDI)?

Answer 32

Democratic institutions, checks and balances.
– Strong property rights.
– Rule of law

Question 33

Why do we see more expropriation of FDI by
autocracies than by democracies?

Answer 33

Some autocratic leaders have greater incentive to
expropriate and face fewer constraints

Question 34

Bilateral Investment Treaties

Answer 34

Agreements between countries that
establish terms and conditions for private
investment by nationals and companies of one
country in the jurisdiction of another.

Question 35

Expropriation

Answer 35

occurs when a public
government agency takes private property for
a purpose deemed to be in the public interest
- examples
- seizure and redistribution of land
- nationalization of oil industry

Question 36

Elkins Guzman & Simmons (2006)

Answer 36

Argument
BITs proliferated because host countries are
competing with each other for limited supply of
FDI from rich countries.
How?
BITs are credible commitments to treat foreign
investors fairly.

Why are BITs credible commitments?
a. Clarify – BIT raises ex post cost of reneging on
contracts by reducing the ambiguity of host
government’s obligations
b. Obligation – BIT raises ex post cost of reneging by
formalizing legal arrangements which states are
bound to follow under international law
c. Enforcement – BIT raises ex post cost of reneging by
establishing enforcement mechanisms including
arbitration tribunals which award monetary
damages.

Key findings:
– Developing “host” countries sign BITs with
industrialized countries to attract foreign capital
– strong evidence for competition mechanism; host
countries rush to secure advantage over one another
* Criticisms of research:
– Some BITs between pairs of developing countries
don’t fit story
– Hard to account for broader political and cultural
environment

Question 37

Expropriation Risk & Institutions

Answer 37

“Host” countries especially want to attract
foreign capital.
* There is risk host countries may expropriate
foreign investment.
* Does the risk depend on domestic institutions?
* MNCs want to reduce risk. Do they avoid
investing in places with “bad” institutions?

Question 38

How does government make credible commitment to
follow the rules?

Answer 38

“Tying hands” through:
* Executive constraints
* Checks and balances
* Party competition
Democracies - Many political constraints
Autocracies - Few political constraints

Question 39

Li (2009

Answer 39

Does the severity of expropriation risk depend
on domestic institutions?
* Expropriation risk depends on domestic
institutions:
– Democratic host governments à lower risk
– Autocratic host governments à higher risk

MNCs want to reduce risk. Do they avoid
investing in places with “bad” institutions?
* MNCs should avoid investing in autocracies
and pursue investments in democracies.

Question 40

Democracy and FDI

Answer 40

Developing countries especially want to attract
foreign capital. Risk of expropriation.
* Severity of the risk depends on domestic institutions
– political constraints help protect property rights
– Democracy à low risk
– Autocracy à high risk
* leaders with long v. short time horizons
* Rational MNCs avoid investing in places with “bad”
institutions.
– Selection bias strengthens Li’s findings

Question 41

Trade and Security

Answer 41

Countries create trade agreements to set
common rules for trade policy and resolve the
international cooperation problem (PD)
* Trade agreements have broader diplomatic
goals like international security. how?
– direct path = bargaining, diplomacy
– indirect path = economic interdependence
(c) Lauren Peritz

Question 42

Mansfield & Pevehouse (2000) theory

Answer 42

Indirect path
* Trade agreements (PTA’s) help countries
maintain low tariffs
* So countries trade more which brings
economic benefits (recall comparative advantage)
* Economic benefits reduce chance of military
conflict among trade partners
– conflict jeopardizes economic benefits; more to lose!

Direct path
* Countries create trade agreements with
dispute settlement mechanisms
* Resolve economic disputes before they
escalate and damage political relations
* Provide forum for bargaining and negotiation
= cooperative norms

Evidence lends support to both mechanisms
1. For states that do not belong to the same
PTA, more tradeà slightly lower risk of
military conflict (economic effect)
2. For states that belong to PTA, more trade à
much lower risk of military conflict
(diplomatic effect)
Criticism: Reverse causality
(c) Lauren Peritz