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

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  • Wenshou Yan

    (School of Economics, University of Adelaide)

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.

Suggested Citation

  • Wenshou Yan, 2016. "Geographic Politics, Loss Aversion, and Trade Policy: The Case of Cotton and China," School of Economics and Public Policy Working Papers 2016-15, University of Adelaide, School of Economics and Public Policy.
  • Handle: RePEc:adl:wpaper:2016-15
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    File URL: https://media.adelaide.edu.au/economics/papers/doc/wp2016-15.pdf
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    Cited by:

    1. Wenshou Yan & Yan Cai & Faqin Lin & Dessie Tarko Ambaw, 2021. "The Impacts of Trade Restrictions on World Agricultural Price Volatility during the COVID‐19 Pandemic," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 29(6), pages 139-158, November.

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    More about this item

    Keywords

    Political economy; Geographic politics; Loss aversion; Reference dependency; Political sensitive product; Price volatility;
    All these keywords.

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • F59 - International Economics - - International Relations, National Security, and International Political Economy - - - Other
    • Q17 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Agriculture in International Trade
    • Q18 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Agricultural Policy; Food Policy; Animal Welfare Policy

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