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Domestic Regulation and International Trade: Where's the Race?

International & National Security Law Practice Group Newsletter - Volume 3, Issue 3, Winter 2000
By Ronald A. Cass
February 01, 2000

INTRODUCTION

Critics claim that international trade undermines a nation's ability to maintain an independent national regulatory structure that would be chosen under democratic-representative processes. The result supposedly is a "race to the bottom" in protection of public interests. Politicians and other commentators frequently conclude that public welfare is reduced by open trade without some mechanism to safeguard domestic regulation or otherwise to secure its ends.

The race-to-the-bottom metaphor builds on economic writings suggesting that, at least under certain conditions, open trade in goods leads to factor price equalization with reduced returns to factors that are relatively abundant in other nations.1 Thus, for example, if low-skilled labor is relatively abundant outside the United States, open trade in products intensively utilizing such labor will (according to this theory) lead to lower real income for low-skilled American workers.2 That conclusion has led to calls for restraining trade, for harmonizing divergent national rules, or for adopting uniform transnational regulatory accords. Economists, however, debate whether this relationship actually describes reality, noting that the conditions from which factor-price-equalization was deduced seldom occur.3

Even if trade does not bring about factor price equalization, its contribution to competition in a domestic economy alters both economic and political activity. The transmission of competitive effects from trade resembles the effects predicted by the race-to-the-bottom metaphor, but trade's competitive effects generally benefit both national economic welfare and individual liberty. The result might be a change in regulation, including a change that would generally be characterized as reducing the scope or bite of regulation. Contrary to the race metaphor's implication, such changes enhance national welfare. The paradigm for trade's effects on domestic regulations, in other words, is provided by Tiebout, not Gresham or Akerlof.4

That trade promotes competition, though generally good news for economic welfare, is both good news and bad in the world of trade politics. Politics, after all, is to some degree-perhaps a very large degree-a world of rent creation, and competition destroys rents. The tendency of politics, hence, inevitably is toward too little competition, including (especially) competition from imports.5 That tendency does not go unchecked, but the checks are not fully availing.

This paper explores both economic and political aspects of the relationship between trade and domestic regulation, looking particularly at lessons that can be drawn from regulation of communications and from export controls. We underscore the importance of trade as a corrective-though only a partial corrective-for ill effects of domestic regulation. Far from limiting the ability of national polities to design regulation favored by each nation's citizens, trade serves (under most conditions) to counteract antidemocratic tendencies in domestic governance, protecting individual liberty in a world of diverse tastes. Further, under some circumstances (ones that seem increasingly common), trade's competition-enhancing effects will be politically preferred to the competition-limiting effects of trade restraints. Unfortunately, trade restrictions still will be imposed too often, in part due to the bias inherent in democratic politics and in part due to personal stakes of decision-makers that are less readily deduced from interests tied to identifiable groups. This last point emerges from examination of export controls (an apparently incongruous set of trade rules) as well as from analysis of import restraints.


I. PRE-RACE REGULATION

Basics of Regulation: Public Interest vs. Public Choice

The starting point for most discussion of trade and regulation is the unexamined assumption that domestic regulation merits protection as the embodiment of popular preferences or alternatively as consisting of normatively attractive programs that advance public good. That is axiomatic if public good is defined as the outcome of governance processes or, perhaps, of governance processes that comport with basic norms of public-democratic decision-making. If the only test is the base acceptability of the governance process, the great bulk of government regulation in the "first world" passes muster.

This may be the proper test for government action in some settings-perhaps for most forms of judicial intervention, for example-but it is hard to see its appeal as an abstract normative standard. Actual acceptance by a majority of citizens, creation of greater aggregate utility or value or wealth for society, or promotion of individual liberty might be better normative goals for government.6

Unlike the assumption in the race metaphor, there is little evidence that much government regulation comports with those abstract norms. Writings in the public interest genre often assume that government regulation is both intended to and in fact does promote widely accepted normative goals, such as efficiency, but those writings do not explain the mechanism for creating public- interested regulations nor do they seriously assess the fit between government action in practice and the posited norm.

Public choice writings, which see government action as the product of self-interested individual behavior, predict systematic divergence of public actions from general public interests.7 On this view, government action typically serves the interests of individuals who can band together in sufficient number at low enough cost to secure a favorable vote on an issue of relatively intense interest to them.8 The interests of a majority of citizens can be served; just as commercial markets composed of individual actors pursuing their individual interests can produce public benefit, so too can government (under certain conditions).9 For example, government can provide public goods-national defense, interstate highways, legal recognition of property rights, protection of public safety-that would be underproduced in private markets.

Even so, the public choice model finds relatively little probability of beneficial government action. The opportunity to create rents for particular groups-benefitting a discrete group while doing much greater harm to the broader public, though seldom visiting a concentrated harm on anyone-has enormous political attraction. The tendency to create rents (typically by restricting competition) does not go unchecked. Three considerations act as counterweights to rent-seeking by interest groups. First, one person's rents are another person's costs. So far as the costs are visited on politically powerful groups, they will act to constrain the rents. Second, though rents commonly are more concentrated (on the supply side) than costs from them (the consumption or demand side), rents can be dissipated in various ways and often will be substantially smaller than costs.10 Third, political decision-makers' incentives will not be fully formed by the balance of rents and costs; other factors will affect the decisional calculus and may tilt it in a direction at odds with what many versions of interest group theory would predict.11 All of these considerations-as well as direct economic effects-influence the political interaction between trade and regulation.

With some regularity, however, government action produces concentrated benefits for a relative few at greater cost to the many. Even where the government seems to be producing public goods, its actions have questionable benefit. In part that is because private markets, though underproducing public goods, still produce a significant level of public goods.12 The comparison of government to private action, hence, cannot compare a world with government-provided public goods to a world bereft of public goods. Further, where government acts to provide public goods, it is apt to provide too many, largely because overproduction can generate private benefits that will be more concentrated than the public costs.13

In line with public choice predictions, writers who have examined regulatory programs critically find that many of them suppress competition in an industry, raising prices to consumers and returns to those who are in the industry.14 Often the regulatory program combines rules that limit competition with ones that mandate cross subsidies (redistribution of joint costs in a manner inconsistent with Ramsey pricing) among services or customers.15 These regulatory schemes are at odds with allocative efficiency and possibly with other attractive norms.


Effects of Government Regulation: Efficiency Concerns

Most serious inquiries into regulations' congruence with public welfare have used efficiency as the standard and have found a series of problems. For the balance of this paper, we assume that the relevant norm is Pareto-efficiency or efficiency under the Bergson-Samuelson social welfare criterion. Regulatory initiatives that mandate (or induce) inefficient pricing tend to reduce output-and wealth-in the regulating nation. Regulation commonly misdirects resources within the regulated industry.16 Under most conditions, that misdirection is not simply an offset against other distortions in the economy (although that is a theoretical possibility).

In addition, regulation also commonly has indirect effects that reduce efficiency, effects tied to the overall level of government intervention rather than to a specific single regulatory scheme.. Three such effects are rent-seeking, lower returns to productive investment, and x-efficiency effects.

First, regulation induces what Professors Jagdish Bhagwati and Ted Srinivasan have termed "directly unproductive" activities and others have termed "rent-seeking" activities: those-lobbying, litigating, and so on-intended to secure, enforce, or retain inefficient regulations.17 The higher the level of inefficient regulation in a jurisdiction, the more resources are likely to be diverted to unproductive activities. That will occur because the high level of inefficient regulation most likely will be taken as a signal of decision-makers' greater propensity to enact inefficient regulation (which raises the expected returns from lobbying, etc.). Moreover, some people who would not find it worthwhile to invest in lobbying merely to move from a competitive arena to a favorable regulatory regime (given their expectations about the magnitude and durability of any rents that might be generated under such a regime) may make a different calculus if they believe that they are choosing between investing in gaining a favorable regime or failing to invest and facing a hostile regulatory regime.

Second, high levels of inefficient regulation, and corresponding investment in unproductive lobbying activities, reduces productive investment incentives. If the prevalence of regulation suggests a heightened propensity to regulate, it suggests a greater probability of future regulation and of the losses that regulation can impose. The prospect of such losses must be considered in making investment decisions.18 Of course, the prospect of gains from regulation will be offset against the potential losses. The net in this calculation, however, should be negative. The expected return on lobbying investment should be the competitive rate of return, and gains from regulation generally should follow lobbying investments; but the costs associated with regulation will be spread throughout the economy, lowering the expected rate of return to investment generally. So far as there are captive assets within the jurisdiction, their price will decline to reflect the lower expected return so that, in equilibrium with fully mobile capital, investment will generate the same real expected return. But these conditions are unlikely to hold; capital restrictions and factor mobility will lead to real variance in investment returns over time periods long enough to have consequence for investment decisions.

The third indirect effect of high levels of inefficient regulation in a polity is the creation of competitive slack, referred to variously as x-efficiency, x-inefficiency, or technical inefficiency. This will not be the result of all regulation, but occurs as a by-product of regulation that reduces competition.

X-efficiency is a concept that is not universally accepted; some academic commentary points out that, contrary to the notion of x-efficiency, even a fully protected monopolist has economic incentives to technical efficiency in production.19 Indeed, because the monopolistic firm (or more broadly, the firm with market power) is more likely than a firm operating in a fully competitive market to capture the benefits of innovations that increase technical efficiency, it is arguable that monopoly reduces such inefficiency rather than causing it.20

For similar reasons, Judge Richard Posner discounts the prospect of monopoly inducing inefficiency through shirking. The common ground for both sides of the debate is that the absence of competitive pressure systematically produces not only higher monetary returns to producers but also higher nonmonetary returns. Presumably, these are offsets, one against the other: personal utility functions include willingness to purchase a variety of goods in exchange for money, including a degree of protection against vigorous policing; and the salaries of the workers who enjoy decreased pressure to work hard should be reduced commensurately to account for their increased slack. Judge Posner, however, drawing on standard agency-cost analysis, observes that so far as the reduced monitoring/increased shirking impairs efficient production and is not offset by appropriate reductions in pay (fully reflecting reduced productivity) an efficient capital market will punish the firm and make it an attractive target for take-over.21

The x-efficiency question in general, thus, is whether the increased slack associated with market power will at any point affect the manner of production so that productivity is decreased or product design is irnpaired or innovation is reduced-and, if so, whether such effects are efficiently monitored by and reflected in capital markets. Those who doubt the reality of x-efficiency believe that efficient capital markets and labor markets adequately control for the potential effects of monopoly power on technical efficiency.

Regulation, however, is different from other bases for market power. Regulation can reduce competition and inhibit full functioning of the normal adjustment mechanisms. For example, regulation that constrains both entry and rates of return can induce inefficient investment in systems redundancy or in other forms of "gold-plating" that can increase the base on which returns are calculated.22 If salaries for top managers are politically sensitive and affect treatment by a regulatory authority, managers might substitute investment in the managers' offices for incremental additions to salary. In neither case is it obvious that the regulatory authority will perfectly police the investments, so that the inefficiency could be consistent with maximizing returns to the regulated firm.23 Similarly, it is plausible to expect inefficient use of inputs by firms that are at once protected from competition and denied full incentives to capitalize on their market power. The normal take-over option often is unavailable given regulatory constraints on ownership as well as on entry. For these reasons, x-efficiency effects are a likely by-product of regulation, even if not otherwise prevalent in advanced economies.24

Regulation and Efficiency: End-Notes

Although we believe that regulation tends to generate inefficiency effects, including x-efficiency effects, two caveats must be noted. First, we do not equate the observation of a tendency to inefficiency-inducing government action with a conclusion that all government action is normatively unattractive. Apart from the question of the right normative standard for judging government action-which would require examination of our assumed standard of Pareto-preferred or Bergson- Samuelson-preferred choices-that conclusion would have to rest on a comparison of real-world alternatives, including alternative institutional arrangements. We have not made that investigation. We do, however, conclude from our observations above that it would be wrong to deem all government action normatively attractive. Contrary to the assumption behind much rhetoric about trade and regulation, the mere fact that a regulatory regime exists is not proof that it is beneficial to the public; that a contemplated action undermines a regulatory regime is not proof that it is inimical to the public. Indeed, our prior is that, in many circumstances, the obverse more often is true.

Second, even if the effects are not fully dissipated through various adjustment mechanisms at any point, the effects of regulatory inefficiencies will be equilibrated through labor and capital markets. Our comments on x-efficiency are not to the contrary. Indeed, one major effect of high levels of regulation is to lower real wages throughout a jurisdiction by acting as a drag on productivity. The reduction in wages does not mean that wages in high-regulation jurisdictions inevitably fie below wages in low-regulation jurisdictions. Given its common adverse effect on productivity, we expect regulation to be correlated positively with wealth and, hence, with productivity.25 High-regulation jurisdictions will tend to be high-productivity jurisdictions, but high-regulation jurisdictions will have lower productivity than they would have but for excessive government regulation. As we discuss below, recognition of that fact is implicit in much of the agitation for harmonization of regulation across jurisdictions.26

The question in the trade-and-regulation discussion, thus, is neither how we prevent the erosion of domestic regulatory programs nor how we induce markets to adjust to regulation. The question must be whether the effects of liberal trade, which influence on-going market adjustments, are positive or negative in the particular changes they induce in domestic regulation.


II. REGULATION AND BUSINESS DECISIONS

The lever commonly focused on for transmission of trade's effects is the decision for businesses to locate production in a particular jurisdiction. The fear of some commentators, and hope of others, is that businesses will move production (locate productive facilities or increase production at such facilities) to jurisdictions that regulate less. Open trade, on this hypothesis, leads to pressure on governments to reduce regulations to levels consistent with exporting jurisdictions. The hypothesis leads different commentators to advocate freer trade, less free trade, or greater coordination of regulations across jurisdictions. Before looking at the transmission mechanism, we pause to ask how regulation intersects business interests.


Regulation and Business Desiderata

Business decisions depend primarily on the specific effects of regulation on a particular business, not on overall levels of regulation or their efficiency effects (though both considerations inform those decisions). From the standpoint of any business, regulation can be good or bad. Regulation can increase or decrease that business's costs or its returns, and it can do so in a one-off manner or in a way that affects marginal costs or marginal revenue. Although a large enough one-time effect can alter production location decisions, those decisions generally will turn on expectations for the marginal costs and marginal revenues of the business.

Revenues might be increased, for instance, by rules that protect local production against competition. Most of these rules, while dampening competition-offsetting an advantage a competitor who is unable (less able) to influence regulation would have in an unrestrained market-do not keep competition fully at bay. The rise of non-price competition among airlines that were constrained in price competition under regulation is a frequently noted example.27 Similarly, location of inefficient scale production in a nation too small to sustain efficient-scale production on the basis of home market consumption often reflects competitive adjustments to regulations that inhibit imports and limit domestic competition.

On the cost side, regulation can help business by lowering marginal costs or harm a business by raising those costs. Rules that reduce the chance of disruptive labor unrest or currency instability or worker illness, that lower the cost of transporting workers to factories or goods to market, or that make it less costly to enforce contracts decrease businesses' marginal costs. Regulation of this sort helps attract business. In contrast, business incentives to locate in the regulating locale are reduced by regulations that impose conditions on work practices costing more than their benefits in greater safety, workers' job satisfaction, or other good; or by rules that limit production methods to achieve gains not internalized by the business (such as environmental improvements that the business will not receive credit for from its customers-at least not enough credit to offset the costs of compliance plus the costs of alerting its customers to the good deed it has done).

Not all regulation that appears adverse to business interests will result in higher marginal costs for business. In many circumstances, additional costs imposed by regulation will be absorbed without affecting marginal costs of production. Land use regulations, for example, tend to be capitalized into the price of land, with new regulatory impositions effectively creating windfall losses (or gains) to affected landowners.28 By and large, however, the effects of regulation will not be fully captured in ways that do not affect on-going business calculations.

Regulations that affect marginal costs and revenues typically divide between sectoral business regulation and general, economy-wide regulation. Sectoral regulation often will advantage a particular business, increasing revenues through direct subsidies (to agriculture, for example) or restrictions on competitive entry. The latter restrictions include direct limitations (as in licensing schemes), import quotas (as with audiovisual industries outside the United States and textiles including the United States), and entry-disadvantaging technical standards.

Although these restrictions are sought by business and serve immediate business interests, it is less clear that they promote long-run health in the protected industry. Indeed, outside a few, narrowly circumscribed exceptions,29 unless they are effective at preventing trade (which often is an intended consequence), competition-limiting sectoral regulations will tend to serve as inducements to trade by increasing the gap between the insulated industry's firms and firms producing the same good outside the protected jurisdiction that compete in the global market.30 Nonetheless, it seems fair, based on short-run effects, to class sectoral regulation generally as marginal-revenue enhancing.


Environmental and Labor Regulation

In contrast to sectoral regulation, which typically is friendly to the most interested domestic business firms, much of the general, economy-wide regulation in advanced economies raises marginal costs for domestic business. Labor and environmental regulations-the focus of so much political attention in the trade-and-regulation debates-largely, but not entirely, fall into these camps.

Let us start with the qualifying phrase, "not entirely." Some environmental regulations may improve health and increase aggregate utility without affecting marginal costs, so far as the environmental gains are internalized within the regulating jurisdiction and the regulatory program represents an efficient mechanism for satisfying workers' tastes for higher air quality or water quality than would otherwise be provided.31 Some set of labor rules, at least if treated as waivable, default rules, may fit the same model.32 But, for the reasons given in the public choice literature, these will be exceptional.

The divergence of environmental regulations from public interests follows from the general disinterest of most citizens about environmental issues coupled with intense interests of several groups. Three groups can be expected to play a disproportionately (relative to voting population or overall value attached to decisions) large role in setting environmental rules. The first group consists of people with unusually high taste for environmental protection. Their interests will be represented both by political entrepreneurs and by individuals whose profession is the representation of others with unusually intense preferences for environmental protection.33 The second group consists of people whose livelihood is tied to activities congruent with those tastes for environmental protection. That group includes people in firms engaged in environmental clean-up, in the production of technologies that are-or, at least, that seem to be-environmentally friendly, and those whose businesses use production methods that are less efficient but more environmentally friendly (in some dimension) than their competitors. The third group consists of people whose livelihood is closely tied to activities especially harmful to the environment, such as those in the leather tanning industry. As Bruce Ackerman and William Hassler's study of the process that produced the economically and environmentally disastrous coal scrubbing rules illustrates, the compromises among these groups almost certainly will produce rules that are neither efficiently tailored to environmental protection nor representative of median citizen preferences.34

Labor regulations generally follow a similar course. The group most intensely interested in labor regulations consists of people who, in a market not subject to those regulations, would not be able to secure the result mandated in the rules.35 Thus, people who would not be hired or promoted or retained in jobs but for a legal imposition have a greater interest in the legal order than those who expect to be similarly positioned in any event. People who expect to be paid far in excess of the minimum wage, who do not expect to face discriminatory job actions, who expect to have the ability to secure employment settings with appropriate pay and perquisites seldom invest in lobbying or other efforts in respect of labor regulations. How many managers who now complain about, for example, the Americans with Disabilities Act (or its state analogues) invested in the legislative debate that framed the act?36

Lobbying on labor rules is not, of course, wholly one-sided. Business firms and their representatives routinely contest against labor rules that organized labor presses for, but the contest is uneven. The reason for that reflects the basis for the increased concern over trade among organized labor's representatives: while labor, especially low-skilled labor, is only modestly mobile, capital is immensely mobile, is to some degree a substitute (as well as a complement) for labor, and can seek other venues if labor rules become overly constraining. Hence, business representatives do not have the same intensity of interest in the contest as representatives of that segment of labor most affected by the rules. This does not mean that the labor interest necessarily prevails. After all, the skew of interest groups operates as an overlay on the dominant influence of the median voter.37 But the skew generally will be in the direction of too much regulation to protect organized labor interests. And, other things equal, the larger and more prosperous the regulating jurisdiction, the more exaggerated this skew is likely to be.38


III. EXPORT CONTROLS: ANOTHER REGULATION, ANOTHER RACE?39

Almost all discussion of trade's intersection with regulation focuses on the manner in which imports affect regulation or regulation affects imports-either domestic regulations are threatened by imports or foreign regulations operate to frustrate imports (which we care about because those are our exports). Economists view exports as necessary to pay for imports, much as giving away something of value in a barter deal is needed to induce the other party to give something of value to you. What makes the deal work is that each party gets something he values more than what is traded away. From a national welfare vantage, exports are good only so far as they make welfare- improving imports possible. The real good is imports.

In the politics of trade, things are reversed: the basic rule of trade politics is that imports are bad, but exports are good. Each of those claims responds to the natural bias of public decision- making in favor of readily identified, easily organized, groups of people intensely interested in an issue. That often translates to a bias in favor of producers of the good at issue. Domestic producers do not want to face competition (from imports or otherwise) in their businesses, and are more likely to achieve success in combating import competition than other domestic competition.40 Domestic producers also want to sell into other markets, and (without opposition, at least not on an equal footing, in the domestic political market) are likely to find domestic politicians sympathetic to that interest.


The Politics of Export Control

This account of the common tendencies of trade politics leaves us with a question: if those tendencies explain import constraints and export promotion, how can we account for export controls? Export controls generally provide gains to a broad, diffuse, unorganized populace (so far as the controls are effective) while the losses are borne largely by a few producers. That formula seemingly should work against the imposition of controls, and yet export controls are imposed with some frequency, often in circumstances where, because of the availability of close substitute sources of supply, they are seemingly incapable of producing any beneficial consequences.41 J. David Richardson estimates that export controls cost the U.S. economy about $29 billion in lost export sales in 1991, and other commentators have given significantly higher estimates.42

Export controls can be explained readily in only two — or maybe one-and-a-half-instances. First are "voluntary export restraints," which are a combination of import restriction and cartel facilitation.43 That fits the standard public choice explanation of political decision-making. Similarly, export controls involving restrictions on export of natural resources present a more traditional setting for government action. In these cases, the principal consumers (for whom the resources are inputs to production of other goods) frequently form a more concentrated group than producers. Because export controls tend to reduce the price of the exportable good, this may be a case of relatively concentrated benefits and more diffuse costs.44

The more common sort of export controls, however, involving finished goods appear to present the opposite situation. This poses something of a conundrum for public choice theory. We offer two hypotheses that might bridge the apparent gap between fact and theory.


Recalibrating Value and Cost

One hypothesis is that the apparent misfit between export controls and public choice theory disappears on examination. The reason is that both the value and cost of export controls might differ from what appears at first blush.

Let us start with the benefit side. Typically, the value assigned to export controls is their effect at preventing negative externalities. That goal is served most obviously by denying an enemy goods that are helpful to that nation and harmful to the restricting nation. Alternatively, the goal is served by influencing actions of a regime that is at least potentially hostile to the restricting nation. Again, the obvious means of influence through export controls is to threaten denial of access to important goods. Frequently, however, export controls are imposed despite the fact that the restricting nation lacks the ability to deny the target nation access to the restricted goods.45 On its face, these instances seem to be all cost, no benefit government actions. Even for the most skeptical observers of government, that is an implausible paradigm.

The first place to look, then, to unravel this enigma is the supposition that the control yields no benefit. If the exporting nation cannot deny technology to an opposed nation, what is gained by export controls?

In addition to the goal of denial, export controls also could serve three other goals for national policy: delay, cost-raising, or signaling. Where denial aims to prevent the target nation from acquiring the restricted good, delay seeks only to maintain some temporal advantage in access to the restricted good. This goal is sometimes derided-it is, on its face, a strategy that results merely in being eaten by the alligator slowly rather than all at once. But, in many circumstances, it may be preferable to be eaten by the alligator more slowly, especially if slow and fast are the only alternatives. To take an example from another context, a dominant firm confronted by entry rarely has the option of maintaining its profits at pre-entry levels, but it often can optimize the trade-off between cutting prices and losing market share.46

The third goal, cost-raising, is more modest yet. In some circumstances, even delaying access to a good is difficult (i.e., too costly). Still, in many contexts, competitors can gain an advantage from raising rivals' costs.47 Restrictions on export are Rely to do this to some degree even if they are only partially successful, in part for the same reason that trade theorists generally favor multilateral liberalization and oppose reciprocal trade agreements: unimpeded, trade will tend to take its most efficient route, while constraints that apply differently to different sources or destinations for trade, even if they cause minimal distortion in production, will cause trade to be diverted to second- best channels.48 Inevitably, there is additional cost associated with trade diversion. Further, if restrictions remove many of the most efficient sources of supply, the effect on rivals' costs-and competitive advantage-could be significant. Some observers have opined that the effect of the mulitnational export control regime directed against the Soviet Union — the Coordinating Committee for Multilateral Export Controls (COCOM) — largely was of this provenance, increasing Soviet expenditures for technology, including expenditures on espionage and bribery to acquire technology from the west and expenditures on less efficient production of similar technology at home.49

Finally, even if utterly ineffective at any of the goals set out above, the "gesture" of restricting exports may possess (political) utility. The action serves as a signal. It lets both domestic and foreign audiences know what we think of particular nations at specific times. The signaling effect may be especially useful if it can be calibrated by the sort of goods in which trade is limited. When you don't get F-18s or Minuteman missiles, that is one thing; when you're off the list to receive silicon chips, that's another; when you stop getting potato chips, things are really serious. The signal of export controls is almost certainly more clear than most diplomatic language and less dangerous than even very moderate military options (such as calling up reserves or other steps toward mobilization).50 A signal of this sort may well influence action by other nations despite its hollowness as a serious constraint on acquisition of restricted goods.

The value of export controls as foreign policy tools, thus, may be substantially greater than would appear from their ability to constrain access, but that still does not answer the question, why would public decision processes favor using this tool? Perhaps this is an example of a general public interest so widely shared and deeply held that officials charged with the government's foreign policy functions-and elected officials whose assent is significant-gain from acting as political entrepreneurs championing this interest.51 That seems a plausible explanation for export controls aimed at the Soviet Union and associated states. As with many issues of general public policy, some members of the public are apt intensely to favor particular policies while others strongly oppose them. Political benefits from export controls flow not simply from general public support but asymmetrically from those who are most intensely supportive of the particular controls.52 The analysis can be extended beyond the decision to impose sanctions to the type of sanctions imposed.53 Hence, even if producer interests play a disproportionate role in decisions respecting export controls, there may be sufficient incentive for officials to impose controls.

The other side of the cost-benefit equation — the cost of export controls to producers — may be more amenable to these decisions than would first appear. The principal effect of export controls in many — but by no means all — instances will be to alter trade patterns rather than to change any firm's sales.

Consider the following hypothetical example. We begin with three, not implausible, conditions: (1) a world market exists for the class of products at issue, with neither production nor consumption concentrated in a single nation; (2) economies of scale are exhausted at volumes of production below the level of consumption (under current conditions and at current prices) in a large economy; and (3) products in this class are differentiated but are reasonably close substitutes. Under these conditions, products will travel across borders, with some imports shipped even to nations that are net exporters of the products at issue. Let the principal producer-exporter nations in this hypothetical be the United States, Japan, and the members of the European Union. When export controls are introduced by one nation-say, a U.S. restriction on sales to Iraq — a short-run shift in supply occurs in that nation as domestic (US) producers seek to sell goods in the home market that previously were expected to be sold in the embargoed market (Iraq). Demand for imports of the product class from noncontrolling nations (Japan and European nations) falls in the controlling nation (the United States), but demand for these imports rises in the embargoed nation (Iraq). Supply from other nations shifts from the controlling nation to the embargoed nation (so that US sales to Iraq are replaced by Japanese or European sales while similar sales of Japanese or European products to U.S. customers are replaced by sales from US producers). Although trade flows change, the new equilibrium output for each firm need not differ appreciably from prior output levels.

Under these conditions, although producers of the controlled products will object to export restrictions, the objection may be quite muted. The restrictions will have an adverse effect on the producers, but the effect need not be large. Indeed, the less effective the government is at gaining international support for the restrictions, the less harm may be done to domestic producers.


Asymmetric Official Incentives

An alternative, and quite different, explanation for export controls is that self-interested behavior of public officials, not serving broader public interests, produces a bias toward overimposition of controls even though the controls impose a real and serious cost on the restricted domestic industries.54 This hypothesis tracks Sam Peltzman's explanation for the Food and Drug Administration's bias toward too much delay in approvals for new drugs.55 Peltzman observed that if a drug was approved that created significant harm to those who used it, the officials who approved the drug would be castigated. If, however, many people were harmed by delays in approval of beneficial drugs, that would lead to less criticism. One error produces costs that are quite readily visible to the public — the Thatidomide scandal, for instance — while the opposed error does not.

With drug approvals, as with export controls, there is a concentrated harm from the less publicly visible error-the companies that seek drug approvals lose profits from the sales they would have made just as the would-be exporters lose profits from the export sales forgone. But in neither case is the risk of offending these firms as great a problem for the public official as the risk of public scandal from an erroneous affirmative grant of authority. The public outcry over our sales of scrap metal to Japan preceding World War II and of arms to Iraq preceding the Gulf War are illustrative.

Perhaps in these circumstances the diffuse public interest in national security is replaced by more personal — but still very widespread — concern that the offending action could be responsible for the loss of a loved one, a family member or friend. Or perhaps in some instances public-interested considerations have greater effect on citizens' behavior than considerations tied more directly to their private interests.56 These are not matters as to which we have sufficient information to draw definite conclusions. We suspect, however, that some aspect of each hypothesis explains the seeming anomaly of export controls.


Conclusion

International trade offers the prospect of increased competition for many businesses. That competition will increase complaints about trade, including complaints that trade undermines domestic regulation. Indeed, trade does in some instances undermine domestic regulation precisely because it increases competition. Firms competing with businesses that are not subject to the same regulation may agitate for regulatory change to reduce burdens that raise the prices of domestic firms' products, and in some instances they will secure the kind of change they demand. The successive changes in the structure of many countries' telecommunications services largely tells a story of this type.

Such changes, though inevitably decried by some, generally will benefit the public. Much of the regulation that will be altered is supported primarily by intensely interested groups despite its costs to a larger portion of the public — costs that tend to be significantly larger than gains to the regulations' proponents. Increased competition will help redress the political imbalance between those who are helped and those who are hurt by much regulation.

Not all regulation is inimical to public interests, and some that will be under pressure as a result of trade could be regulation that is relatively helpful to public welfare. These instances in the main will involve spillover effects captured to different degrees in various nations. In such settings, there is a clear role for international agreement to regulate harms that are not sustainably regulable by individual nations with open trade. Even here, however, trade closure almost surely will not be a first-best solution and is not predictably the best second-best solution.

The opposition to trade's effects, captured in the race-to-the-bottom metaphor, misleads in arguing that there is a simple, direct connection between trade and regulatory change, in arguing that the change leads to a single, low-regulation system globally, and in arguing that the change impairs domestic welfare. In fact, regulation will change at different paces in a variety of ways, at times moving against the grain that increased trade-generated competition suggests. Trade rarely will lead to a single, uniform regulatory system. And the change will tend to promote, not impair, welfare, as the strong tendency is toward too much restriction of competition, including too much restriction of trade — even in circumstances where trade restriction seems at odds with conventional political dynamics, as with export controls. The one place the race to the bottom seems to be occurring as trade expands is in the rhetoric used to describe how trade and regulation interact.

Copyright: Ronald A. Cass & John R. Haring 1998. Prepared for 1998 General Meeting of the Mont Pelerin Society. Printed with permission.

* Ronald A. Cass is Dean and Melville Madison Bigelow Professor of Law, Boston University School of LAw; Member, Vice Chairman, U.S. International Trade Commission, 1988-90.

** John R. Haring is Principal, Strategic Policy Research; Chief Economist and Chief, Office of Plans & Policy, Federal Communications Commission, 1987-90.


  1. Stolper & Samuelson, 1941; Samuelson, 1948; Samuelson, 1949.
  2. Murphy & Welch, 1991; Borjas, Freeman & Katz, 1992. But see Bhagwati, 1968 (trade-linked welfare reduction, like growth-linked welfare reduction, traces to underlying welfare-distorting policy, not independently to trade or growth).
  3. Deardorff, 1986.
  4. Compare Akerlof, 1970, with Tiebout, 1956. Although the Tiebout (voting-with-the-feet) effect can only reach Pareto-efficient results under certain conditions, Buchanan & Goetz, 1972, it suggests a mechanism for achieving closer correspondence of preferences and public choices. In that respect, it is closer to the trade paradigm than are the various incarnations of lemons effects.
  5. E.g., Schattschneider, 1935; Baldwin, 1985; Destler, 1986; Bhagwati, 1988.
  6. We find the concept of aggregate utility helpful despite frequently expressed reservations about it. Those reservations go more to the mechanism for assessing aggregate utility (or changes in aggregate utility) or to the choice of aggregate utility as the appropriate normative standard for a given decision than they do to the underlying notion that personal utility can have an aggregate that is meaningful.
  7. See, e.g., Buchanan & Tullock, 1962.
  8. See, e.g., Olson, 1965.
  9. Note impossibility under Arrow conditions. Arrow, 1963.
  10. See, e.g., Hufbauer, Berliner & Elliott, 1994; Buchanan, Tollison & Tullock, 1980.
  11. See Niskanen, 1971; McKean, 1972; Peltzman, 1973.
  12. See, e.g., Coase, 1974. As Coase show, the divide between ordinary goods and pure public goods is fictive. Markets produce many goods with significant public goods characteristics.
  13. Buchanan & Tullock, 1962.
  14. See, e.g., Friedman, 1962; Spann & Erickson, 1970; MacAvoy, 1971; Gellhorn, 1976; Hazlett, 1991.
  15. E.g., Posner, 1971.
  16. See, e.g., Haring, 1984; Mitchell & Vogelsang, 1991.
  17. Bhagwati & Srinivasan, 1980; Buchanan, Tollison & Tullock, 1980; Bhagwati, 1982; Collander, 1984.
  18. Kaplow, 1986.
  19. E.g., Posner, 1975.
  20. Id.; Posner, 1998, at 304-05.
  21. Id. at 480.
  22. Averch & Johnson, 1962. A-J-W- effect literature.
  23. See, e.g., Kahn, 1988, vol. 2 at 49-59.
  24. Our own belief is that advanced economies have sufficient distortions of efficiency-inducing mechanisms, including takeovers, that x-efficiency effects are not limited to pervasively regulated industries.
  25. See also Schumpeter, 1942; Olson, 1982.
  26. See also Bhagwati, 1996; Cass & Boltuck, 1996; Leebron, 1996.
  27. See Douglas & Miller, 1974; Bailey, Graham & Kaplan, 1986.
  28. The term "windfall" should be qualified here, as the losses/gains from regulatory actions can be as predictable as losses/gains from changes in consumers' tastes or other matters that affect business. See, e.g., Kaplow, 1986.
  29. The protection of an "infant industry" may be such an exception. See, e.g., Corden, 1971. Undeniably, claims that conditions apposite to such protection obtain far exceed instances in which such protection is beneficial.
  30. Bhagwati, 1988; Crandall, 1991; Cass & Haring, 1998.
  31. See, e.g., Stewart, 1993; Deardorff, 1997.
  32. For explication of the role of default rules from somewhat different perspectives, see, e.g., Ayres & Gernter, 1989; Gillette, 1990.
  33. Public and private representatives of broadly held interests often are treated together as political entrepreneurs, though we use the term solely for public representatives. See Shepsle & Bonchek, 1997.
  34. Ackerman & Hassler, 1981.
  35. We do not here posit any particular set of legal rules or wealth distributions as defining the pre-regulation market. We simply indicate that there is a status quo ante the regulatory action, and whatever that is would not support the result desired by those who seek the regulation. Were that not so, investment in securing the regulation would be pointless..
  36. For discussion of difficulties with this and other regulations, see Howard, 1994; Olson, 1997.
  37. See, e.g., Olson, 1965; Mueller, 1989.
  38. See Schumpeter, 1942; Olson 1982.
  39. Part IV is adapted from Cass & Haring, 1998, chaps. 4 & 9.
  40. Baldwin, 1985; Bhagwati, 1988; Krueger, 1995.
  41. Hufbauer, Schott & Elliott, 1990.
  42. Richardson, 1993. Richardson does not consider restrictions on the sale of "pure weaponry" and does not estimate costs of compliance with government export controls. Estimates of U.S. losses from export controls on dual-use (military or civilian) technology run as high as $125 billion. See, e.g., Hearings on H.R. 2912, Sep. 1993, at 13-16 (testimony of Robert E. Allen, Chairman & CEO, American Tel. & Tel.); BNA Special Report, Sep. 1993.
  43. Jones, 1994.
  44. We are grateful to Henry Manne for making this point. For a description of the economies of export restraints and their benefits to domestic consumers, see Corden, 1971, at 15-16.
  45. Hufbauer, Schott & Elliott, 1990; Richardson, 1993; Burnham, 1994; Cass & Haring, 1998.
  46. See, e.g., Stigler, 1964.
  47. See Salop & Scheffman, 1983; Krattenmaker & Salop, 1986.
  48. Lindsey, 1960; Bhagwati, 1994, This does not, however, mean that all preferential arrangements are trade-reducing. See Deardorff & Stern, 1994, at 27-75.
  49. Artemiev, 1991; Hillenbrand, 1992, at 68; McDaniel, 1993, at 117.
  50. McDaniel, 1993; Cass & Haring, 1998.
  51. See, e.g., Ordeshook, 1986, at 184-87; Mueller, 1989, at 180-93.
  52. See Kaempfer & Lowenberg, 1988.
  53. See Spindler, 1995.
  54. Cass & Haring, 1998. See also Long, 1989, at 69-107; Spindler, 1995.
  55. Peltznabm 1973.
  56. See Kau & Rubin, 1979; Kalt & Zupan, 1984; Peltzman, 1984. See also Kaempfer & Lowenberg, 1988.