Loss aversion and trade policy

Caroline Freund (clfreund@ucsd.edu) and Caglar Ozden

No 3385, Policy Research Working Paper Series from The World Bank

Abstract: This paper provides new survey evidence showing that loss aversion and reference dependence are important in shaping people's perception of trade policy. Under the assumption that agents'welfare functions exhibit these behavioral elements, we analyze a model with a welfare-maximizing government and with the lobbying framework of Grossman and Helpman (1994). The policy implications of the augmented models differ in three important ways. One, there is a region of compensating protection, where a decline in the world price leads to an offsetting increase in protection, such that a constant domestic price is maintained. Two, protection following a single negative price shock will be persistent. Three, irrespective of the extent of lobbying, there will be a deviation from free trade that tends to favor loss-making industries. The augmented models are more consistent with the observed structure of protection, and in particular, explain why many trade policy instruments are explicitly designed to maintain prices at a given level.

Keywords: Payment Systems&Infrastructure; Economic Theory&Research; Markets and Market Access; Environmental Economics&Policies; Insurance&Risk Mitigation; Economic Theory&Research; Environmental Economics&Policies; TF054105-DONOR FUNDED OPERATION ADMINISTRATION FEE INCOME AND EXPENSE ACCOUNT; Insurance&Risk Mitigation; Markets and Market Access (search for similar items in EconPapers)
Date: 2004-09-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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