- Email: [email protected]
Cascading contingent protection
European Economic Review 36 (lo92) 883-892. Nortb-
GA TT Secretariat, Geneva, Switzerland
Michael P. Leidy GATTSecretariat, Geneoa, Switzerland University of Arizona, Tucson AZ, USA Received November 1990, tinal version received August 1991
This paper extends the literature on the incentive effects of contingent protection by identifying and analyzing the vertical linkages that may exist across instances of contingent trade policy. It is shown that the accessibility of contingent protection in a downstream industry may pro:;de additional inducement for upstream suppliers of intermediate inputs to ursue contmgent protection as well. In general, access to instruments of contingent protection at more than one stage of the production stream enhances the opportunity for components producers to engage in indirect rent seeking. Contingent protection may be pursued precisely because of the likelihood of downstream injury and cascading protection.
Since the mid-1970s industries in a number of major industrialized countries have resorted increasingly to administered forms of protection from foreign competition. The most frequently used measure in the EC and the US. is antidumping (AD). AD is an instrument of ‘contingent’ protection, in that certain necessary conditions need to be satisfied before it is invoked. Under AD law, duties may be imposed on imported products if it can be shown that these are sold at ‘less than fair value’ and such sales have caused injury to domestic producers of similar products.’ Experience has shown Correspondence to: B.M. Hoekman and M.P. Leidy, GATT Secretariat, Centre William Rappard, Rue de Lausanne 154, Case Postale, CH-1211 Geneva 21, Switzerland. *The views expressed in this paper are our own and should not be attributed to the GATT Secretariat. We are grateful to Kym Anderson, Mark Koulen, Patrick Messerlin, Robert Stern, Matthew Tharakan, and an anonymous referee for comments on an earlier version. Special thanks are in order to Professor Jean Waelbroeck whose comments substantially improved the paper. ‘Less than fair value (dumping) is defined as arising when export prices are below prices charged in the home market or below a ‘constructed value’ for unit costs. For a recent crosscountry review of AD legislation, see Jackson and Vermulst (1990). 00142921/92/$05.00 0 1992-Elsevier
Science Publishers B.V. All rights reserved
884
B.M. Hoekrnan and M.P. Leidy, Cascading contingent
protection
that demonstrating ‘dumping’ is generally not a binding constraint since the procedures employed tend to be biased.’ In practice, the o requirement a domestic industry must satisfy is that imports have caused, or threaten to cause, ‘material’ injury. 3 While rules for contingent protection help to deflect lobbying pressure away from legislatures to ‘low track’ rulesbased fora (like AD),4 this does not imply that there is no scope for petitioning industries to influence the decision to grant protection. However, unlike the lobbying activities undertaken to influence legislated protection, firms seeking protection through administrative channels must find indirect means of affecting the process. This paper extends the literature on the political economy of protection by identifying a vertical linkage across instances of contingent trade policy. The analysis is motivated by two paradoxes. First, upstream firms sometimes seek protection which, due to the implied increase in input prices, stands to severely injure, and perhaps destroy, their downstream customers. On the face of it this appears irrational. Why should upstream industries inflict severe harm downstream when doing so jeopardizes their own market? Second, downstream firms often do not register their opposition to instances of cost-increasing upstream protection. Indeed, Destler and Ode11 (1987, p. 46) note that there have been examples of unaffiliated downstream firms (customers) supporting bids for protection upstream. Again, such behavior appears to be contrary to the interests of downstream lirns and is in striking contrast to the resistance usually offered by industries to other sources of upward pressure on costs (e.g. resistance to wage pressures from organized labor). The formal analysis presented in this paper rationalizes such behavior.’ Upstream p;otection seeking in such cases is sometimes part of a
“See, for examp le, Finger and Mutray (1990), Messerlin (1989), Hindley (1988), or Boltuck et al. (1990). ‘The material injury standard is not defined clearly. Indicators of injury include market share, profits, capacity utilization, and employment, but not all of these need to be declining. Also, since establishing that imports are the cause of injury is difficult, perhaps impossible [Grossman (1986)], injury per se is all that needs to be established. See Finger and Murray (1990) and Kaplan (1991) for more detailed discussions. 4The .listinction between ‘low’ and ‘high’ track procedures was made by Finger, Hall, and Nelson (1982). Destler (1986) provides a discussion of the political forces that led the U.S. Congress to require import-competing industries to pursue low track procedures. ‘Those familiar with AD legislation might hypothesize that in the U.S. context, nonopposition of user industries may be because they have no legal standing. This reflects the fact that U.S. AD actions do not have to be in the pub!% interest. Nonetheless, user industries can certainly register their opposition to upstream protection if they desire, via a public relations campaign for example. In other jusisdictions (e.g., the EC and Canada) downstream sectors do have legal standing. Our interest in this paper is to determine the conditions under which downstream nonopposition or support is rational. Whether or not users have legal standing in AD procedures in not relevant in this connection.
B.M. Workman
stratt;gy
and M.P.
Leidp,
Cascading
contingent
protection
885
of ‘In
invoking instruments of contingent protection, an earn industry may have the power to significantly injure downstream import-competing industries. This increases the probability that downstream firms will seek and gain protection in turn. Even if an upstream industry knows that there are no direct profits available from petitioning for protection, it may expect to increase profits indirectly by iridu~ing protection downstream. Indeed, by initiating and winning an AD action, upstream suppliers may be able to manipulate the hea!th of downstream firms to the advantage 0s both. As a result instances of contingent protection tend to cascade down the production stream. Research by Feinberg and Kaplan (1990) provides evidence of cascading.7 In a statistical analysis of all antidumping and countervailing duty cases brought by U.S. producers and users of metals during 198&86, they found that user industries tended to hle for protection after upstream industries, and that the share of all cases accounted for by downstream industries increased significantly over time. An analysis of cases involving producers and users of chemicals led to the same finding.’ While suggestive, it should not be concluded that the causal flow from upstream to downstream protection is purely mechanistic. The injury transmitted to the downstream sector, together with the extent to which this affects the probability of protection downstream, certainly provides the energy that binds protectionist events. But, perhaps more importantly, the initiation of an upstream petition for protection (the initial force), and whether or not a downstream sector will register its opposition, depends on the beliefs of each about the effectiveness of this transmission mechanism. When the expected transmission is rather ‘jAs discussed in Leidy and Hoekman (1991) indirect rent-seeking involves attempts to manipulate the criteria established for gaining protection in order to enhance the probability of winning protection. Often this takes the form of firms adjusting their decision variables so as to move closer to the point at which an injury investigation will end in a favourable ruling. Hillman, Katz anti Rosenberg (1987) studied a form of indirect rent seeking in which the employment decision takes on an insurance function in that it can be used to enhance the probability cf protection by affecting the political visibility of the industry. ‘We are grateful to Matthew Tharakan for drawing out attention to this paper. The model developed below differs from theirs in that it treats the decision to seek protection explicitly, identifies the necessary and suflicient conditions for cascading to occur, incorporates the expectation of cascading in the upstream decision, and considers the relationship between upstream and downstream protection in probabilistic terms. ‘The history of steel protection in the United States also provides anecdotal evidence of cascading. Starting in the late 196Os,semi-finished steel products such as ingots, sheets, bars and wire benefitted from import barriers. Input-output tables indicate that producers of steel springs, metal cans, fasteners (nuts and bolts), railroad equipment, motor vehicle parts, and bearings are among the heaviest users of steel. The ball bearing and industrial fastener industries sought and obtained protection during the second half of the 1970s. Producers of railroad passenger cars and undercarriage components initiated aittidumping and countervailing duty cases during the early 198Os,while the motor vehicle industry obtained relief from imports after the initiation of a Section 201 complaint which resulted in the 1981 negotiation of a VER with Japan. See Hufbauer. Berliner and Elliot (1986) cases M-15, M-20 and M-22, USITC (1982, 1984) and ;‘JSTR (1985).
886
5.M.
Hoekman
and M.P.
Leidy,
Cascading
contingent
protection
weak, this may be enough to prevent initiation upstream. Alternatively, when the transmission is rather strong, this may induce an upstream petition that might not otherwise have been pursued. The next section examines these connections in a model of protection seeking at two stages of pro 2. contingent protectio ad vertically iinke Consider two independent domestic import-competing industries: one producing a component and the other producing a final good that requires the component as an input. Neither is currently protected from foreign competition. Each may seek import barriers by petitioning for AD duties.g The following formalization expresses the problem facing an industry association in the upstream sector. lo It chooses to pursue protection (9 = 1) or not (s” =0) according to max 4(s”,P)Q+[l
-q(sU,t?“)]l7;-C-S”,
(1)
s=eio. 1)
where iti is the expected value of profit if protection is granted,” II,” is profit if protection is not granted, c is the processing cost associated with a bid for protection and the function q(s”,O”) denotes the probability that protection will be granted upstream as a function of the choice variable and other exogenous factors represented by 8”. Such factors include the probability that a dumping margin will be found, the state of the business cycle, past behavior of the investigating authority with respect to its receptiveness to finding injury, and political intangibles not under the control of the industry. Of course, protection cannot be won unless the industry asks for it, i.e., q(0,f3") =0 V 19". Actual profit under protection is not known ex ante since it will depend on whether or not protection is granted downstream. The ‘Although the focus is on AD, many AD cases in the EC end with bilateral price or quantity agreements, while a large percentage of initiated AD complaints in the ?_.S. are withdrawn before a final determination, often due to agreement on a VER being reached [Messcrlin (1989), Finger and Murray (1990)]. “A:ticle 5.1 of the GATT Antidumping Code specifies that an AD allegation must be initiated by or on behalf of the industry affected. Of course, it is well known that protection has the characteristics of a public good. While all ol’ the difficulties associated with the private provision of public goods are often present, it can be noted that existing AD procedures do not require that all firms in an industry participate in a petition [see Jackson and Vermu.lst (1990, pp. 87, 152)-J. In what follows we simply assume that the internalization problem has been solved. The large number of AD actions taken in the US and EC suggests that this is not a strong assumption. “Throughout superscripts identify the industry (u = upstream, d =downstreamj and subscripts identify siates (p=protection and f=no protection). Normal profitability (or any fixed level of supranormal pro&t) is assumed to obtain in the absence of protection upstream. Hence fl! is fixed. This assumption helps to simplify the exposition without loss of generality since what matters is the size of ii”, relative to II;, whether or not the latter term is expressed as an expected value.
oekman and M.P. Leidy, Cascading contingent
protection
887
tage of any market power n the presence or absence e downstream industry can be expressed analogously with one important asymmetry. Protection upstream generally results in higher input prices. This will tend to reduce downstream profits and output, while imports will rise to fill the implied demand gap. As the joint appearance of ‘injury’ (declining profits and output) and rising imports are necessary conditions for contingent protection to be granted, this increases the probability that contingent protection will be granted if sought by the downstream industry. The state of upstream protection tends, therefore, to enhance the probability of protection downstream through the transmission of injury while simultaneously reducing the profits associated with any given state. Formally the downstream industry’s problem can be expressed as
max ~(s~,O~,~)~~~(~)+~~-~(S~,O~,U)]I~~(U)-C~S~, sdE(o, I)
(2)
where p(sd, ed,u) is the probability of winning a bid for protection. The variable ME (0,l) represents the state of the upstream market, where U= 1 indicates that protection has been granted upstream, and u=O indicates it has not. Due to the transmission-of-injury effect, p( 1, Bd,1) >~(1,8~,0) for all Bd. Also, through the effect on the component price, n:(O) > n:(l) and n;(o) > n;( 1). It is clear from problem (1) that the likelihood of protection being pursued upstream depends critically on the size of & relative to II+‘. If, for example, nisZ7;, then it will never pay to seek protection. The size of I!: depends, in turn, on the likelihood that the dowirstream sector will also obtain protection. The upstream industry will recognize this dependence in solving problem (1) and this is reflected in the following expression for expected profit under upstream protection: &=I&+(1
-+7;,.
(3)
The term II:, is upstream profit under upstream and downstream protection, I& is upstream profit under upstream protectio:; but free trade downstream (ni,>&), and 1 is the upstream sector’s assessment of the probabilit:r that protection will be sought and granted downstream given that it has been granted upstream. That is, the term 1 captures the upstream sector’s attempt to anticipate the downstream industry’s decic.lon, and implicitly enters problem (1) through &. Letting 52 denote the information set available to the upstream industry concerning the characteristics of problem (2) (the downstream decision problemj, 1 can be expressed as
888
8.
. .vloekman and M.P. lAeidy, Cascading contingent protection
.-I= E[p(Zd, dd,1) 1n-J,
(4)
where E is the expected va me operator, and ti! For example, SE might, but need not, contain ail of the structure and parameter values in problem (2). If so, then the values of sd and 8’ are known and A.= p(sd, 8, l).” Other things equal, the greater the injury transmitted downstream the closer I is to unity. This can be seen by examining problem (2). If p( 1, od, 1) is close to cne and F;(l) is large relative to A!:(l), then the upstream sector can be quite confident that the downstream sector wi!l indeed seek (sd = 1) and win protection. Of course, as A becomes large the value & in eq. (3) becomes increasingly irrelevant to the upstream sector’s decision expressed in (1). The fact that an upstream sector might seek protection that stands to inflict serious injury downstream, potentially jeopardizing the demand for its output, might appear paradoxical :o those focusing on the direct implications for upstream profits (i.e., the relativeiy low value of L!if). But the apparent irrationality disappears as the value c.f ;7if declines in significance relative to that of _Q,. The attractiveness of seeking protection upstream appears through the enhanced prospect of protection downstream, and the resulting increase in expected profits for the upstream industry. If, however, the transmission of injury is expected not to induce a high like!ihocd of downstream protection, then this knowledge may tend to inhibit upstream seeking. This can be summarized in the following proposition: Proposition I. When an upstream sector seeks protection that stands to severely harm its domestic downstream customers the motivation must lie in the expectation that the transmission of injury will make downstream protectiorz highly likely.
When will it be in the interest of a downstream sector to either support or not oppose an upstream bid for protection ?13 The structure of problem (2) provides the basis for observing both the paradox noted by Destler and its resolution. The source of the paradox is that upstream ly a reduction in downstream profits under any possible state of the wo downstream, i.e., n”,( 1) -Cnd,(O) and n,“( 1) c n:(O). But as (0), support of upstream seeking can be rationalized if a ercentage increase in the probability of protection down‘?Jn general, the more information that is available to the upstream sector, the more concentrated the distributions of P and gd become around the values actually facing the downstream industry in problem (2). “For simplicity we will assume that ‘support’, ‘non-opposition’, and ‘opposition* impose a negligible cost on downstream firms. This does not, however, affect the central message of the analysis.
, c~sc~~i~~ cQnt~~genFprotecFion
Fig. 1. Necessary and sufficient conditions for a downstream protection.
889
sector to gain from upstream
stream can more than offset the decline in state-specific profits. If so, upstream protection confers an external benefit downstream, rather than a loss. The appropriate focus is not the implied loss within states due to upstream protection, but the implied change in the likelihood of each state. These cbservations can be expressed more formally as follows. Let Y(@‘,u,c) denote the indirect expected profit function implied by the solution to problem (2). Then whenever !P(ed, l,c)> Y(Od,O,~), the downstream sector experiences a positive externality associated with an upstream bid for protection. If the upstream bid is successful, the enhanced probability of protection increases the downstream sector’s expected profit. For this to be possible thz closed intervals [n:(l), n”,(l)] and [n:(O), nd,(O)] must overlap. When this holds there exists a convex combination of the endpoints in the first interval that exceeds a convex combination of the endpoints in the second interval. Fig. 1 represents these relationships schematically on the real line. The possibility of a mutually advantageous bid for protection upstream requires that pC be sufficiently small so that pJ7$0) +( 1 -po)#(0) < I$( l), where p. is the probability of protection downstream under the optimal choice in problem (2) given there is no upstream protection (u=O).‘” It also requires that p1 be sufficiently large that plL$( 1) +( 1 -pr)@( l)>&‘(O). These are necessary but not sufficient conditions. Alternatively, it can be concluded that the sets (5) C(Pl,~~(l),~~(l),~;‘(o))Iplnd,(l)+(1-PPl)~~(l)<~td(0)j and 14The parameter pi= p(_p**,0, i), where s*’ is the optimal choice in problem (2) and i = 1,O.
890
B.M. Noekman and M.P. Leidy, Cascading contingent
protection
parameter values that preclude a mutua!ly advantageous upstrea bid for protection. Fig. I shows an example of parameter values for which a successful upstream bid for protection makes the downstream sector better off ex ante. All of this establishes the second proposition. Proposition 2. An upstream bid for protection may confe; an external benefit on a downstream industry in the ex ante sense [f I!“,(l)>@(O), and the transmission of injury downstream causes a sufficient increase in the the probability of downstream protection.
A special case is noteworthy. Suppose that downstream Lms are initially just normally profitable in the absence of upstream protection. Then profitability below L!:(O) in fig. 1 is insufficient for the industry to remain viable. In such a case, upstream protection stands to destroy the viability of the downstream industry, other things equal, since IT:<1) represents negative economic profits. The elasticity of supply downstream to any marginal increase in upstream protection is infinite. Thus by obtaining protection the upstream sector virtually guarantees that protection will consequently be sought and won downstream, thereby restoring its economic viability. This is an extreme example in which the prospect of severely damaging the health of downstream customers will not necessarily deter an upstream industry from seeking protection. To the contrary it may encourage it.
Both of the foregoing propositions depend on the causal link between upstream and downstream protection through the transmission of injury. An upstream sector may find a bid for protection to be attractive despite the direct harm inflicted on its downstream customers, as long as there is a reasonable expectation that this harm will be offset by subsequent protection downstream. When a downstream sector supports an upstream bid for protection, the model suggests that its intent must be to seek protection for itself rlrld that it expects upstream protection to assist in that pursuit. Rather than a source of division that might have countered efforts to use ‘unfair trade laws’ as a vehicle for restricting competition, the vertical transmission of advantageous injury suggests an unexpected confluence of interests that cartelization efforts. These sectors are thus not always may help to bi natural enemies. ecause of the injury criteria established under current rules, ds’. Various ways have been identified in the they may be ‘unnatural literature in which anti ping law can facilitate the cartelization of an
B.M.
~oekma~
and
.P.
Leidy, Cascading contingent
protection
891
two recent e
I990) has shown actions fosters de facto cartel~zatio~, and that D has been used by industries to enforce existing cartels. Staiger and Wolak (1989) have argued that a credible AD threat provides a means for industries to engage in implicit collusion that could not otherwise be maintained. The vertical linkage across instances of contingent protection suggests an additional way in which AD procedures may foster cartelization at several stages along the production stream. This paper has examined conditions under which instances of contingent protection will tend to cascade down the production stream, motivated by empirical observations that upstream firms may pursue protection that stands to injure downstream customers, and that the latter may not oppose indeed may support: - such upstream bids for protection. The connections between instances of contingent protection in the presence of vertically-linked markets are twofold: one rather obvious, the other more subtle. Contingent protection tends to flow downstream naturally because of the transmission of injury. Even when upstream suppliers give no thought to the welfare of their downstream customers, the transmission of injury establishes a vertical link across instances of contingent protection. But in addition to this, contingent protection may be pursued preciseiy because of the likelihood of downstream injury and cascading protection. In this way the upstream industry engages in indirect rent seeking. It has been suggested that rules for contingent protection create moral hazard problems, since they establish an insurance policy not available to nonimport-competing sectors.15 This paper points to another dimension of this problem in rhe sense that the insurance payoff will depend in part on whether the fire set upstream burns down the downstream neighbour’s house. Without the possibility of engaging in this form of indirect rent seeking, one would expect fewer instances of intervention seeking in upstream industries, more anti-protectionist activity by downstream sectors, and the absence of cases where unaffiliated downstream firms actually support upstream bids for protection. ‘SExamples of the distortions created by the rules for contingent protection appear in Hillman, Katz and Rosenberg (1987), and Leidy and Hoekman (1991). Dixit (1987) also analyzes the problem of moral hazard under the prospect of protection from foreign competition.
eferences Boltuck, Richard, Joseph Francois and Seth Kaplan, 1990, The economic implications of the current administration of U.S. unfair trade lr;ws, in: Richard Boltuck and Robert Litan, eds., Down in the dumps: The U.S. unfair trade laws (The Brookings Institution, Washington, DC). Destler, I.M., 1984, American trade politics: System under stress (Institute for International Economics, Washington, DC). Destler I.M. and John Odell, 1987, Anti-protection: Changing forces in United States trade pol;tics (Institute for International Economics, Washington, DC).
E.E.R.
E
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B.M.
Hoekman
and
M.P.
Leidy, Cascading contingent protection
Dixit, Avinash. !987, Trade and insurance with moral hazard, Journal of International Economics 23, 201-220. Feinberg, Robert and Seth Kaplan, 1990, Fishing downstream: The political economy of effective protection, Working paper 91-01-L (Research Division, U.S. Jnternational Trade Commission, Washington, DC). Finger, J. Michael and Tracy Murray, 1990, Policing unfair imports: The United States example, Journal of World Trade 24, no. 4, 39-55. Finger, J. Michael, H. Keith Hall and Douglas Nelson, 1982, The political economy of administered protection, American Economic Review 72, 452-466. Grossman, Gene, 1986, Imports as a cause of injury: The case of the U.S. steel industry, Journal of International Economics 24201-223. Hillman, Arye, Eliakim Katz and Jacob Rosenberg, 1987, Workers as insurance: Anticipated government assistance and factor demand, Oxford Economic Papers 39,813-820. Hindley, 1988, Dumping and the Far East Trade of the European Community, The World Economy l&445-463. Hutbauer, Gary, Diane Berliner and Kimberly Elliot, 1986, Trade protection in the United States: 31 case studies (Institute for International Z-momics, Washington, DC). Jackson, John and Edwin Vermulst, eds., 1990, Antidumping law and practice: A comparative study (University of Michigan Press, Ann Arbor, MI). Kaplan, Seth, 1991, Injury and causation in USITC antidumping determinations: Five recent views, in: Matthew Tharakan, ed., Policy implications of antidumping measures (NorthHolland, Amsterdam). Leidy, Michael and Bernard Hoekman, 1991, Spurious injury as indirect rent-seeking: Free trade under the prospect of protection, Economics and Politics 3, 11f-137. Messerlin, Patrick, 1989, The EC antidumping regulations: A first economic appraisal, 1980-85, We!:wirtschaftliches Archiv 125, 563-587. Messerlin, Patrick, 1990, Antidumping regulations or procartel law? The EC chemical cases, The World Economy 3.465-492. Staiger, Robert and Frank Wolak, 1989, Strategic use of antidumping law to enforce tacit international collusion, Working paper 3016 (NBER, Cambridge, MA). United States International Trade Commission, 1980 and 1984, Operation of the trade agreements program (USITC, Washington DC). United States Trade Representative, 1985, Annual report of the president on the trade agreements program (USTR, Washington, DC).
GA TT Secretariat, Geneva, Switzerland
Michael P. Leidy GATTSecretariat, Geneoa, Switzerland University of Arizona, Tucson AZ, USA Received November 1990, tinal version received August 1991
This paper extends the literature on the incentive effects of contingent protection by identifying and analyzing the vertical linkages that may exist across instances of contingent trade policy. It is shown that the accessibility of contingent protection in a downstream industry may pro:;de additional inducement for upstream suppliers of intermediate inputs to ursue contmgent protection as well. In general, access to instruments of contingent protection at more than one stage of the production stream enhances the opportunity for components producers to engage in indirect rent seeking. Contingent protection may be pursued precisely because of the likelihood of downstream injury and cascading protection.
Since the mid-1970s industries in a number of major industrialized countries have resorted increasingly to administered forms of protection from foreign competition. The most frequently used measure in the EC and the US. is antidumping (AD). AD is an instrument of ‘contingent’ protection, in that certain necessary conditions need to be satisfied before it is invoked. Under AD law, duties may be imposed on imported products if it can be shown that these are sold at ‘less than fair value’ and such sales have caused injury to domestic producers of similar products.’ Experience has shown Correspondence to: B.M. Hoekman and M.P. Leidy, GATT Secretariat, Centre William Rappard, Rue de Lausanne 154, Case Postale, CH-1211 Geneva 21, Switzerland. *The views expressed in this paper are our own and should not be attributed to the GATT Secretariat. We are grateful to Kym Anderson, Mark Koulen, Patrick Messerlin, Robert Stern, Matthew Tharakan, and an anonymous referee for comments on an earlier version. Special thanks are in order to Professor Jean Waelbroeck whose comments substantially improved the paper. ‘Less than fair value (dumping) is defined as arising when export prices are below prices charged in the home market or below a ‘constructed value’ for unit costs. For a recent crosscountry review of AD legislation, see Jackson and Vermulst (1990). 00142921/92/$05.00 0 1992-Elsevier
Science Publishers B.V. All rights reserved
884
B.M. Hoekrnan and M.P. Leidy, Cascading contingent
protection
that demonstrating ‘dumping’ is generally not a binding constraint since the procedures employed tend to be biased.’ In practice, the o requirement a domestic industry must satisfy is that imports have caused, or threaten to cause, ‘material’ injury. 3 While rules for contingent protection help to deflect lobbying pressure away from legislatures to ‘low track’ rulesbased fora (like AD),4 this does not imply that there is no scope for petitioning industries to influence the decision to grant protection. However, unlike the lobbying activities undertaken to influence legislated protection, firms seeking protection through administrative channels must find indirect means of affecting the process. This paper extends the literature on the political economy of protection by identifying a vertical linkage across instances of contingent trade policy. The analysis is motivated by two paradoxes. First, upstream firms sometimes seek protection which, due to the implied increase in input prices, stands to severely injure, and perhaps destroy, their downstream customers. On the face of it this appears irrational. Why should upstream industries inflict severe harm downstream when doing so jeopardizes their own market? Second, downstream firms often do not register their opposition to instances of cost-increasing upstream protection. Indeed, Destler and Ode11 (1987, p. 46) note that there have been examples of unaffiliated downstream firms (customers) supporting bids for protection upstream. Again, such behavior appears to be contrary to the interests of downstream lirns and is in striking contrast to the resistance usually offered by industries to other sources of upward pressure on costs (e.g. resistance to wage pressures from organized labor). The formal analysis presented in this paper rationalizes such behavior.’ Upstream p;otection seeking in such cases is sometimes part of a
“See, for examp le, Finger and Mutray (1990), Messerlin (1989), Hindley (1988), or Boltuck et al. (1990). ‘The material injury standard is not defined clearly. Indicators of injury include market share, profits, capacity utilization, and employment, but not all of these need to be declining. Also, since establishing that imports are the cause of injury is difficult, perhaps impossible [Grossman (1986)], injury per se is all that needs to be established. See Finger and Murray (1990) and Kaplan (1991) for more detailed discussions. 4The .listinction between ‘low’ and ‘high’ track procedures was made by Finger, Hall, and Nelson (1982). Destler (1986) provides a discussion of the political forces that led the U.S. Congress to require import-competing industries to pursue low track procedures. ‘Those familiar with AD legislation might hypothesize that in the U.S. context, nonopposition of user industries may be because they have no legal standing. This reflects the fact that U.S. AD actions do not have to be in the pub!% interest. Nonetheless, user industries can certainly register their opposition to upstream protection if they desire, via a public relations campaign for example. In other jusisdictions (e.g., the EC and Canada) downstream sectors do have legal standing. Our interest in this paper is to determine the conditions under which downstream nonopposition or support is rational. Whether or not users have legal standing in AD procedures in not relevant in this connection.
B.M. Workman
stratt;gy
and M.P.
Leidp,
Cascading
contingent
protection
885
of ‘In
invoking instruments of contingent protection, an earn industry may have the power to significantly injure downstream import-competing industries. This increases the probability that downstream firms will seek and gain protection in turn. Even if an upstream industry knows that there are no direct profits available from petitioning for protection, it may expect to increase profits indirectly by iridu~ing protection downstream. Indeed, by initiating and winning an AD action, upstream suppliers may be able to manipulate the hea!th of downstream firms to the advantage 0s both. As a result instances of contingent protection tend to cascade down the production stream. Research by Feinberg and Kaplan (1990) provides evidence of cascading.7 In a statistical analysis of all antidumping and countervailing duty cases brought by U.S. producers and users of metals during 198&86, they found that user industries tended to hle for protection after upstream industries, and that the share of all cases accounted for by downstream industries increased significantly over time. An analysis of cases involving producers and users of chemicals led to the same finding.’ While suggestive, it should not be concluded that the causal flow from upstream to downstream protection is purely mechanistic. The injury transmitted to the downstream sector, together with the extent to which this affects the probability of protection downstream, certainly provides the energy that binds protectionist events. But, perhaps more importantly, the initiation of an upstream petition for protection (the initial force), and whether or not a downstream sector will register its opposition, depends on the beliefs of each about the effectiveness of this transmission mechanism. When the expected transmission is rather ‘jAs discussed in Leidy and Hoekman (1991) indirect rent-seeking involves attempts to manipulate the criteria established for gaining protection in order to enhance the probability of winning protection. Often this takes the form of firms adjusting their decision variables so as to move closer to the point at which an injury investigation will end in a favourable ruling. Hillman, Katz anti Rosenberg (1987) studied a form of indirect rent seeking in which the employment decision takes on an insurance function in that it can be used to enhance the probability cf protection by affecting the political visibility of the industry. ‘We are grateful to Matthew Tharakan for drawing out attention to this paper. The model developed below differs from theirs in that it treats the decision to seek protection explicitly, identifies the necessary and suflicient conditions for cascading to occur, incorporates the expectation of cascading in the upstream decision, and considers the relationship between upstream and downstream protection in probabilistic terms. ‘The history of steel protection in the United States also provides anecdotal evidence of cascading. Starting in the late 196Os,semi-finished steel products such as ingots, sheets, bars and wire benefitted from import barriers. Input-output tables indicate that producers of steel springs, metal cans, fasteners (nuts and bolts), railroad equipment, motor vehicle parts, and bearings are among the heaviest users of steel. The ball bearing and industrial fastener industries sought and obtained protection during the second half of the 1970s. Producers of railroad passenger cars and undercarriage components initiated aittidumping and countervailing duty cases during the early 198Os,while the motor vehicle industry obtained relief from imports after the initiation of a Section 201 complaint which resulted in the 1981 negotiation of a VER with Japan. See Hufbauer. Berliner and Elliot (1986) cases M-15, M-20 and M-22, USITC (1982, 1984) and ;‘JSTR (1985).
886
5.M.
Hoekman
and M.P.
Leidy,
Cascading
contingent
protection
weak, this may be enough to prevent initiation upstream. Alternatively, when the transmission is rather strong, this may induce an upstream petition that might not otherwise have been pursued. The next section examines these connections in a model of protection seeking at two stages of pro 2. contingent protectio ad vertically iinke Consider two independent domestic import-competing industries: one producing a component and the other producing a final good that requires the component as an input. Neither is currently protected from foreign competition. Each may seek import barriers by petitioning for AD duties.g The following formalization expresses the problem facing an industry association in the upstream sector. lo It chooses to pursue protection (9 = 1) or not (s” =0) according to max 4(s”,P)Q+[l
-q(sU,t?“)]l7;-C-S”,
(1)
s=eio. 1)
where iti is the expected value of profit if protection is granted,” II,” is profit if protection is not granted, c is the processing cost associated with a bid for protection and the function q(s”,O”) denotes the probability that protection will be granted upstream as a function of the choice variable and other exogenous factors represented by 8”. Such factors include the probability that a dumping margin will be found, the state of the business cycle, past behavior of the investigating authority with respect to its receptiveness to finding injury, and political intangibles not under the control of the industry. Of course, protection cannot be won unless the industry asks for it, i.e., q(0,f3") =0 V 19". Actual profit under protection is not known ex ante since it will depend on whether or not protection is granted downstream. The ‘Although the focus is on AD, many AD cases in the EC end with bilateral price or quantity agreements, while a large percentage of initiated AD complaints in the ?_.S. are withdrawn before a final determination, often due to agreement on a VER being reached [Messcrlin (1989), Finger and Murray (1990)]. “A:ticle 5.1 of the GATT Antidumping Code specifies that an AD allegation must be initiated by or on behalf of the industry affected. Of course, it is well known that protection has the characteristics of a public good. While all ol’ the difficulties associated with the private provision of public goods are often present, it can be noted that existing AD procedures do not require that all firms in an industry participate in a petition [see Jackson and Vermu.lst (1990, pp. 87, 152)-J. In what follows we simply assume that the internalization problem has been solved. The large number of AD actions taken in the US and EC suggests that this is not a strong assumption. “Throughout superscripts identify the industry (u = upstream, d =downstreamj and subscripts identify siates (p=protection and f=no protection). Normal profitability (or any fixed level of supranormal pro&t) is assumed to obtain in the absence of protection upstream. Hence fl! is fixed. This assumption helps to simplify the exposition without loss of generality since what matters is the size of ii”, relative to II;, whether or not the latter term is expressed as an expected value.
oekman and M.P. Leidy, Cascading contingent
protection
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tage of any market power n the presence or absence e downstream industry can be expressed analogously with one important asymmetry. Protection upstream generally results in higher input prices. This will tend to reduce downstream profits and output, while imports will rise to fill the implied demand gap. As the joint appearance of ‘injury’ (declining profits and output) and rising imports are necessary conditions for contingent protection to be granted, this increases the probability that contingent protection will be granted if sought by the downstream industry. The state of upstream protection tends, therefore, to enhance the probability of protection downstream through the transmission of injury while simultaneously reducing the profits associated with any given state. Formally the downstream industry’s problem can be expressed as
max ~(s~,O~,~)~~~(~)+~~-~(S~,O~,U)]I~~(U)-C~S~, sdE(o, I)
(2)
where p(sd, ed,u) is the probability of winning a bid for protection. The variable ME (0,l) represents the state of the upstream market, where U= 1 indicates that protection has been granted upstream, and u=O indicates it has not. Due to the transmission-of-injury effect, p( 1, Bd,1) >~(1,8~,0) for all Bd. Also, through the effect on the component price, n:(O) > n:(l) and n;(o) > n;( 1). It is clear from problem (1) that the likelihood of protection being pursued upstream depends critically on the size of & relative to II+‘. If, for example, nisZ7;, then it will never pay to seek protection. The size of I!: depends, in turn, on the likelihood that the dowirstream sector will also obtain protection. The upstream industry will recognize this dependence in solving problem (1) and this is reflected in the following expression for expected profit under upstream protection: &=I&+(1
-+7;,.
(3)
The term II:, is upstream profit under upstream and downstream protection, I& is upstream profit under upstream protectio:; but free trade downstream (ni,>&), and 1 is the upstream sector’s assessment of the probabilit:r that protection will be sought and granted downstream given that it has been granted upstream. That is, the term 1 captures the upstream sector’s attempt to anticipate the downstream industry’s decic.lon, and implicitly enters problem (1) through &. Letting 52 denote the information set available to the upstream industry concerning the characteristics of problem (2) (the downstream decision problemj, 1 can be expressed as
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. .vloekman and M.P. lAeidy, Cascading contingent protection
.-I= E[p(Zd, dd,1) 1n-J,
(4)
where E is the expected va me operator, and ti! For example, SE might, but need not, contain ail of the structure and parameter values in problem (2). If so, then the values of sd and 8’ are known and A.= p(sd, 8, l).” Other things equal, the greater the injury transmitted downstream the closer I is to unity. This can be seen by examining problem (2). If p( 1, od, 1) is close to cne and F;(l) is large relative to A!:(l), then the upstream sector can be quite confident that the downstream sector wi!l indeed seek (sd = 1) and win protection. Of course, as A becomes large the value & in eq. (3) becomes increasingly irrelevant to the upstream sector’s decision expressed in (1). The fact that an upstream sector might seek protection that stands to inflict serious injury downstream, potentially jeopardizing the demand for its output, might appear paradoxical :o those focusing on the direct implications for upstream profits (i.e., the relativeiy low value of L!if). But the apparent irrationality disappears as the value c.f ;7if declines in significance relative to that of _Q,. The attractiveness of seeking protection upstream appears through the enhanced prospect of protection downstream, and the resulting increase in expected profits for the upstream industry. If, however, the transmission of injury is expected not to induce a high like!ihocd of downstream protection, then this knowledge may tend to inhibit upstream seeking. This can be summarized in the following proposition: Proposition I. When an upstream sector seeks protection that stands to severely harm its domestic downstream customers the motivation must lie in the expectation that the transmission of injury will make downstream protectiorz highly likely.
When will it be in the interest of a downstream sector to either support or not oppose an upstream bid for protection ?13 The structure of problem (2) provides the basis for observing both the paradox noted by Destler and its resolution. The source of the paradox is that upstream ly a reduction in downstream profits under any possible state of the wo downstream, i.e., n”,( 1) -Cnd,(O) and n,“( 1) c n:(O). But as (0), support of upstream seeking can be rationalized if a ercentage increase in the probability of protection down‘?Jn general, the more information that is available to the upstream sector, the more concentrated the distributions of P and gd become around the values actually facing the downstream industry in problem (2). “For simplicity we will assume that ‘support’, ‘non-opposition’, and ‘opposition* impose a negligible cost on downstream firms. This does not, however, affect the central message of the analysis.
, c~sc~~i~~ cQnt~~genFprotecFion
Fig. 1. Necessary and sufficient conditions for a downstream protection.
889
sector to gain from upstream
stream can more than offset the decline in state-specific profits. If so, upstream protection confers an external benefit downstream, rather than a loss. The appropriate focus is not the implied loss within states due to upstream protection, but the implied change in the likelihood of each state. These cbservations can be expressed more formally as follows. Let Y(@‘,u,c) denote the indirect expected profit function implied by the solution to problem (2). Then whenever !P(ed, l,c)> Y(Od,O,~), the downstream sector experiences a positive externality associated with an upstream bid for protection. If the upstream bid is successful, the enhanced probability of protection increases the downstream sector’s expected profit. For this to be possible thz closed intervals [n:(l), n”,(l)] and [n:(O), nd,(O)] must overlap. When this holds there exists a convex combination of the endpoints in the first interval that exceeds a convex combination of the endpoints in the second interval. Fig. 1 represents these relationships schematically on the real line. The possibility of a mutually advantageous bid for protection upstream requires that pC be sufficiently small so that pJ7$0) +( 1 -po)#(0) < I$( l), where p. is the probability of protection downstream under the optimal choice in problem (2) given there is no upstream protection (u=O).‘” It also requires that p1 be sufficiently large that plL$( 1) +( 1 -pr)@( l)>&‘(O). These are necessary but not sufficient conditions. Alternatively, it can be concluded that the sets (5) C(Pl,~~(l),~~(l),~;‘(o))Iplnd,(l)+(1-PPl)~~(l)<~td(0)j and 14The parameter pi= p(_p**,0, i), where s*’ is the optimal choice in problem (2) and i = 1,O.
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B.M. Noekman and M.P. Leidy, Cascading contingent
protection
parameter values that preclude a mutua!ly advantageous upstrea bid for protection. Fig. I shows an example of parameter values for which a successful upstream bid for protection makes the downstream sector better off ex ante. All of this establishes the second proposition. Proposition 2. An upstream bid for protection may confe; an external benefit on a downstream industry in the ex ante sense [f I!“,(l)>@(O), and the transmission of injury downstream causes a sufficient increase in the the probability of downstream protection.
A special case is noteworthy. Suppose that downstream Lms are initially just normally profitable in the absence of upstream protection. Then profitability below L!:(O) in fig. 1 is insufficient for the industry to remain viable. In such a case, upstream protection stands to destroy the viability of the downstream industry, other things equal, since IT:<1) represents negative economic profits. The elasticity of supply downstream to any marginal increase in upstream protection is infinite. Thus by obtaining protection the upstream sector virtually guarantees that protection will consequently be sought and won downstream, thereby restoring its economic viability. This is an extreme example in which the prospect of severely damaging the health of downstream customers will not necessarily deter an upstream industry from seeking protection. To the contrary it may encourage it.
Both of the foregoing propositions depend on the causal link between upstream and downstream protection through the transmission of injury. An upstream sector may find a bid for protection to be attractive despite the direct harm inflicted on its downstream customers, as long as there is a reasonable expectation that this harm will be offset by subsequent protection downstream. When a downstream sector supports an upstream bid for protection, the model suggests that its intent must be to seek protection for itself rlrld that it expects upstream protection to assist in that pursuit. Rather than a source of division that might have countered efforts to use ‘unfair trade laws’ as a vehicle for restricting competition, the vertical transmission of advantageous injury suggests an unexpected confluence of interests that cartelization efforts. These sectors are thus not always may help to bi natural enemies. ecause of the injury criteria established under current rules, ds’. Various ways have been identified in the they may be ‘unnatural literature in which anti ping law can facilitate the cartelization of an
B.M.
~oekma~
and
.P.
Leidy, Cascading contingent
protection
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two recent e
I990) has shown actions fosters de facto cartel~zatio~, and that D has been used by industries to enforce existing cartels. Staiger and Wolak (1989) have argued that a credible AD threat provides a means for industries to engage in implicit collusion that could not otherwise be maintained. The vertical linkage across instances of contingent protection suggests an additional way in which AD procedures may foster cartelization at several stages along the production stream. This paper has examined conditions under which instances of contingent protection will tend to cascade down the production stream, motivated by empirical observations that upstream firms may pursue protection that stands to injure downstream customers, and that the latter may not oppose indeed may support: - such upstream bids for protection. The connections between instances of contingent protection in the presence of vertically-linked markets are twofold: one rather obvious, the other more subtle. Contingent protection tends to flow downstream naturally because of the transmission of injury. Even when upstream suppliers give no thought to the welfare of their downstream customers, the transmission of injury establishes a vertical link across instances of contingent protection. But in addition to this, contingent protection may be pursued preciseiy because of the likelihood of downstream injury and cascading protection. In this way the upstream industry engages in indirect rent seeking. It has been suggested that rules for contingent protection create moral hazard problems, since they establish an insurance policy not available to nonimport-competing sectors.15 This paper points to another dimension of this problem in rhe sense that the insurance payoff will depend in part on whether the fire set upstream burns down the downstream neighbour’s house. Without the possibility of engaging in this form of indirect rent seeking, one would expect fewer instances of intervention seeking in upstream industries, more anti-protectionist activity by downstream sectors, and the absence of cases where unaffiliated downstream firms actually support upstream bids for protection. ‘SExamples of the distortions created by the rules for contingent protection appear in Hillman, Katz and Rosenberg (1987), and Leidy and Hoekman (1991). Dixit (1987) also analyzes the problem of moral hazard under the prospect of protection from foreign competition.
eferences Boltuck, Richard, Joseph Francois and Seth Kaplan, 1990, The economic implications of the current administration of U.S. unfair trade lr;ws, in: Richard Boltuck and Robert Litan, eds., Down in the dumps: The U.S. unfair trade laws (The Brookings Institution, Washington, DC). Destler, I.M., 1984, American trade politics: System under stress (Institute for International Economics, Washington, DC). Destler I.M. and John Odell, 1987, Anti-protection: Changing forces in United States trade pol;tics (Institute for International Economics, Washington, DC).
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Dixit, Avinash. !987, Trade and insurance with moral hazard, Journal of International Economics 23, 201-220. Feinberg, Robert and Seth Kaplan, 1990, Fishing downstream: The political economy of effective protection, Working paper 91-01-L (Research Division, U.S. Jnternational Trade Commission, Washington, DC). Finger, J. Michael and Tracy Murray, 1990, Policing unfair imports: The United States example, Journal of World Trade 24, no. 4, 39-55. Finger, J. Michael, H. Keith Hall and Douglas Nelson, 1982, The political economy of administered protection, American Economic Review 72, 452-466. Grossman, Gene, 1986, Imports as a cause of injury: The case of the U.S. steel industry, Journal of International Economics 24201-223. Hillman, Arye, Eliakim Katz and Jacob Rosenberg, 1987, Workers as insurance: Anticipated government assistance and factor demand, Oxford Economic Papers 39,813-820. Hindley, 1988, Dumping and the Far East Trade of the European Community, The World Economy l&445-463. Hutbauer, Gary, Diane Berliner and Kimberly Elliot, 1986, Trade protection in the United States: 31 case studies (Institute for International Z-momics, Washington, DC). Jackson, John and Edwin Vermulst, eds., 1990, Antidumping law and practice: A comparative study (University of Michigan Press, Ann Arbor, MI). Kaplan, Seth, 1991, Injury and causation in USITC antidumping determinations: Five recent views, in: Matthew Tharakan, ed., Policy implications of antidumping measures (NorthHolland, Amsterdam). Leidy, Michael and Bernard Hoekman, 1991, Spurious injury as indirect rent-seeking: Free trade under the prospect of protection, Economics and Politics 3, 11f-137. Messerlin, Patrick, 1989, The EC antidumping regulations: A first economic appraisal, 1980-85, We!:wirtschaftliches Archiv 125, 563-587. Messerlin, Patrick, 1990, Antidumping regulations or procartel law? The EC chemical cases, The World Economy 3.465-492. Staiger, Robert and Frank Wolak, 1989, Strategic use of antidumping law to enforce tacit international collusion, Working paper 3016 (NBER, Cambridge, MA). United States International Trade Commission, 1980 and 1984, Operation of the trade agreements program (USITC, Washington DC). United States Trade Representative, 1985, Annual report of the president on the trade agreements program (USTR, Washington, DC).