Inequity Aversion and the International Distribution of Trade Protection

Since World War II, trade barriers have come down around the world.  While the degree of liberalization has varied across both countries and industries, there is a puzzle: Why do so many countries continue to more heavily protect lower-earning, less-skilled industries?  An important reason this pattern is puzzling is it holds true even in many low-income countries for which less-skilled industries are likely to be comparative-advantage sectors and thus receive less trade protection, not more. Existing theories tend to explain support for winners or for losers, but they do not explain why lower-earning sectors seem to be preferred in the process of setting trade support in almost all countries.

In our study, we proposed one possible explanation for this phenomenon: individual preferences over trade policies that are shaped by considerations of others, above and beyond one’s own income.  We developed a formal model based on our theory, the intuition of which incorporates social preferences commonly known as inequity aversion (Fehr and Schmidt 1999).  Here, individuals are altruistic toward others if their material payoffs are below an equitable benchmark and are envious of others whose payoffs are above this level.  In our model, the form of inequity aversion has two distinct parts.  Advantageous inequality aversion is the loss individuals incur because others realize worse material outcomes than they do, while disadvantageous inequality aversion is the loss individuals incur because others realize better outcomes than they do.

To test our argument we conducted surveys in both the United States and China in 2009, countries where less-skilled-intensive sectors are comparative-disadvantage and comparative-advantage industries, respectively.  Our experimental design asked respondents to consider trade protection for industries with randomly assigned different wage levels, and then recorded their support for sector-specific trade protection.  Importantly, we also collected each respondent’s own income level, which allowed us to measure whether his/her income was higher or lower than the industry-wage in question. We evaluated our argument using this data in two ways. First, we report the results of our experimental manipulation of the average wage in the industry under consideration for protection. We find that support for protection increases by 16% in China and 26% in the United States when respondents consider a low-wage industry compared to an average-wage industry. Industries with lower wages receive broader support for protection in both countries. Second, we estimate the inequality aversion parameters of our theoretical model. This econometric analysis yields strong evidence that individual attitudes towards trade protection indeed display both advantageous and disadvantageous inequality aversion.

Our research indicates that above and beyond self-interest, inequity aversion helps shape the trade policies governments select.  Moreover, it seems quite likely that other-regarding preferences may help shape other government fiscal and social policies. In societies marked by significant inequality, political conflict over economic policy is a function of both how policy alternatives affect individual interests and how these alternatives resonate with individual beliefs about the fairness of the distribution of economic outcomes.

About the author: Xiaobo Lu is an Assistant Professor of Government, the University of Texas at Austin, Kenneth Scheve is Professor of Political Science at Stanford University and Senior Fellow at the Freeman Spogli Institute for International Studies and Matthew J. Slaughter is Signal Companies Professor of Management and Associate Dean at Tuck School of Business at Dartmouth and National Bureau of Economic Research. Their article, “Inequity Aversion and the International Distribution of Trade Protection”, appears in the July 2012 issue of the American Journal of Political Science.

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The American Journal of Political Science (AJPS) is the flagship journal of the Midwest Political Science Association and is published by Wiley.