The effect of the industrial structure on trade policy: A game-theoretic model and empirical tests applied to national economy and economic integration

It is generally believed that public goods will be underprovided because of free riding. However, there are differences of opinion about the causes of free riding. Olson (1965) argued that fewer group members means less free riding and thus there will be more of the public good provided. Some empirical studies favor Olson, while others get opposite results. In addition, there have been a number of laboratory experiments, which also got very mixed results. Noting the public good aspect of a tariff for import-competing producers and using the theory of endogenous protection by Magee, Brock, and Young (1989), I derive a testable relationship between the provision of public goods and the number of potential providers in a game-theoretic setting. I provide a precise theoretical specification for free riding and in simulations find that tariffs rise dramatically and nonlinearly as industry concentration increases beyond Hefindahl values of 1800.; I test the functional relationship between trade protection and both the Herfindahl industry concentration index and a free riding coefficient. This is a more theory-based method to explain trade protection. I establish how lobby free riding can be measured even without data on lobby contributions and estimate the effect of free riding on industry tariffs. Estimates indicate that free riding was high--nearly 70%.; I extend the free riding discussion to economic integration. Endogenous protection predicts that there will be two effects of the formation of a customs union on a union's external tariff. The first is "tariff diversion" because free riding will increase as there is a larger number of firms in a customs union, all contributing for the same external tariff. This causes the external tariff of a customs union to fall. The second effect is "tariff creation" which occurs for two reasons. First, the external tariff will rise because the increase in industry concentration resulting from mergers among firms reduces lobby free riding and thus increases lobbying for protection. This tariff creation effect is strengthened by the addition of the compensation effect which captures political support for firms in adversity from the removal of intra-union tariffs through firms' lobbying for higher external tariffs.; This chapter estimates these two effects using data from the formation of the European Community. The results indicate that the tariff diversion reductions in external protection were nearly as large as the tariff creation increases in external protection. Thus, the much feared "fortress Europe" effects on external protection from a United Europe are largely unfounded.