Rent Dissipation, Political Viability, and the Strategic Adoption of Free Trade Agreements

Abstract

This paper studies the political viability of free trade agreements (FTAs). The key element of the analysis is the “rent dissipation” that these arrangements induce: by eliminating intra-bloc trade barriers, an FTA lowers the incentives of the local firms to lobby for higher external tariffs, thereby causing a reduction of the rents created in the lobbying process. The prospect of rent dissipation moderates the governments’ willingness to participate in FTAs; they will support only arrangements that are “substantially” welfare improving, and no FTA that reduces national welfare. Accounting for the possibility of political turnover, rent dissipation creates also “strategic” motivations for the formation of FTAs. Specifically, a government facing a high enough probability of losing power may want to form a trading bloc simply to “tie the hands” of its successor. An FTA can affect the likelihood of political turnover as well. If the incumbent party has a known bias toward special interests, commitment to less distortionary policies would reduce its electoral disadvantage; the rent dissipation effect ensures that an FTA can serve as the vehicle for such a commitment. In fledgling democracies, an incumbent government can use a free trade agreement also to reduce the likelihood of dictatorial takeover, thus helping “consolidate” democracy.