On Trade, Distributional Conflict, and Endogenous Regime Change

Abstract

Can we expect shocks in trade openness to affect the quality of the domestic political process, and in what way? Isolating cross-country heterogeneity in the distributional effects of trade shocks for different relative factor endowments as a critical element for theory development, the paper tackles the puzzle by formally developing and solving a new probabilistic model to link the distributional effects of shocks to endogenous institutional change via induced conflict between a capital-intensive and a labour-intensive coalition. The model of distributional conflict combines a political selection stage to select the rate of income redistribution by majority voting and a constitutional conflict stage among factor-intensive coalitions whose steady state outcome determines the level of institutional inequality assigning the “rules“ of political selection. The former is modelled via a canonical weighted median voter setup with the (infinitely many) weights-distributions induced by the value of the steady state outcome of the constitutional conflict stage, while the latter is modelled as a Tullock contest with an endogenous contest success function and the heterogeneous coalition prizes equalling the expected value of the contest to each coalition as a function of the coalitions' efforts. Closed form solutions are derived for (i) the expected outcome of distributional conflict in terms of institutional quality and (ii) the intensity of conflict. Via comparative static analysis based on the Stolper Samuelson theorem in Heckscher-Ohlin trade theory, it is formally shown that positive shocks in trade openness always induce higher institutional inequality irrespective of heterogeneity in the underlying distributional effects, but that the expected mechanisms driving the drop in quality differ across capital-abundant and labour-abundant countries.