Geographic Politics, Loss Aversion, and Trade Policy: The Case of Cotton and China

Wenshou Yan

No 2016-15, School of Economics and Public Policy Working Papers from University of Adelaide, School of Economics and Public Policy

Abstract: This paper seeks to explain how governments respond to world market price fluctuations. It develops a theoretical model of trade policy incorporating loss aversion and reference dependence. Like Freund and Özden (2008), this paper assumes only trade policy instruments are available to the government, but it goes beyond their model by adding a spatial dimension to interest-group politics. The model suggests that: (1) politically sensitive products receive more trade protection; (2) the government’s changing trade distortions insulate the domestic market from international price fluctuations by setting trade protection lower (higher) when the world price is higher (lower) than a targeted domestic reference price; and (3) variations in market intervention help producers at the expense of consumers in periods when the international price is well below trend, and help consumers at the expense of producers in high-price periods. These predictions from theory are shown to still hold when the model is extended to a large country case involving terms of trade effects. The model is tested empirically and found to offer a plausible explanation of the puzzling changes in cotton protection in China.

Keywords: Political economy; Geographic politics; Loss aversion; Reference dependency; Political sensitive product; Price volatility (search for similar items in EconPapers)
JEL-codes: F13 F14 F59 Q17 Q18 (search for similar items in EconPapers)
Date: 2016-11
New Economics Papers: this item is included in nep-cna, nep-int and nep-tra
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Journal Article: Geographic politics, loss aversion and trade policy: The case of cotton in China (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:adl:wpaper:2016-15

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