Essays on the Political Economy of Domestic and Trade Policies in the Presence of Production and Consumption Externalities

This dissertation extends the Grossman-Helpman models of endogenous trade policy formation to incorporate local and global production and consumption externalities, and to allow governments to choose domestic production or consumption policies together with trade interventions. The models presented are among the first to allow environmental quality and the structure of industry protection to be simultaneously evaluated in a political economy framework, when some industry groups lobby their governments for higher output prices.

The equilibrium tax and subsidy policies are implicitly expressed as the sum of distinct political support, terms-of-trade, and local and global environmental effects. Whether these effects reinforce or counterbalance each other depends on whether an industry is organized, whether the good is imported or exported, whether the externality is caused by production or consumption, and, in the large-country models, on whether governments set policies noncooperatively or cooperatively.

The model results imply a political economy version of Bhagwati's normative targeting principle: governments use the most efficient policy available to satisfy the lobbies, to address the externalities, and, in the noncooperative large-country model, to exploit international market power. All of the initial Grossman-Helpman results (for the small-country model and the noncooperative and cooperative large-country models) are shown to be special cases where governments have only trade policy available and there are no externalities.

In the small-country model and the cooperative large-country model, when there are production externalities, the lobbying of a polluting industry usually leads to lower environmental quality than socially optimal, but with terms-of-trade effects or for particular preferences cases the equilibrium policies may induce environmental quality higher than socially optimal. When there are consumption externalities, and the government has consumption (or production) as well as trade policy available, environmental quality will be socially optimal (again, unless governments exploit market power). Thus, depending on the policies available, a local or global consumption externality will be fully internalized, even though polluting industries lobby and production may be distorted. This dissertation also shows that--in contrast to standard economic theory--the use of trade policy alone can lead to higher environmental quality than a more direct domestic policy alone.