A Theory of Unilateral Trade Policy

We integrate strategic-trade and political-economy considerations in a unified framework to analyse unilateral trade policy. Foreign firms compete on Home's market through export or foreign direct investment (FDI). They also lobby Home's government which sets trade (tariff) and industrial (tax) policies to maximize a weighted sum of domestic welfare and lobby contributions. We show that protection by a low-cost Home may improve global welfare by inducing a more cost-efficient global production pattern. The strategic-trade motive for unilateral intervention to increase domestic welfare may prevail even without domestic firms, and may be enhanced by the presence of FDI firms. The political motive to induce lobby contributions may mitigate or even reverse strategic-trade motivated policy deviations, and trade policy deviation need not benefit special interests to be politically optimal. If the government cares more about lobby contributions than about domestic welfare, it is more likely to adopt a liberal rather than a protectionist trade policy, regardless of its impact on lobbies.