Public Choice98: 43–57, 1999.© 1999Kluwer Academic Publishers. Printed in the Netherlands.

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Growth, the external terms of trade and endogenous tradeliberalization

JOHN DEVEREUX1 & LEIN LEIN CHEN2

1Department of Economics, University of Miami Coral Gables, Florida 33124, U.S.A.;2Department of Economics, University of Nevada, Las Vegas, Las Vegas 89154, U.S.A.

Accepted 18 November 1996

Abstract. We study the effects of growth and changes in the external terms of trade onprotection. There are two sectors, an urban sector and a rural sector, and trade policy is usedto redistribute income between them. We show that growth precedes trade liberalization. Inaddition, we find that trade reform is triggered by falls in the world prices of primary exportsor intermediate imports. These results are shown to hold for tariffs and quotas.

1. Introduction

Throughout the developing world, countries have started to open their econo-mies. Trade liberalization has occurred in the rapidly growing economies ofEast Asia as well as in Latin America and Africa. For many observers, thesedevelopments are the result of pressure from international organizations suchas the World Bank or the IMF while for others they represent the triumphof the export promotion approach to development. Of course, skeptics maywonder why international organizations should have become so powerful orwhy policy makers in countries with such widely differing economic andpolitical conditions should suddenly have become convinced by academicarguments in favor of freer trade after decades of ignoring them.1 In thispaper, by contrast, we argue that recent trade reforms can be explained as aresult of changes in the economic environment rather than as a consequenceof exogenous shifts in political preferences or external influences.

To support our argument, we provide a simple model of endogenous tradeliberalization based on the political support function approach of Peltzman(1976) and Hillman (1982). In our model there are two sectors, an urban sec-tor and a rural sector, and trade policy is used to redistribute income betweenthem. We find that trade liberalization is triggered by exogenous growth aswell as by falls in the prices of primary exports or imported intermediateinputs such as oil.

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The hypothesis that commercial policy responds to changes in the exter-nal terms of trade is not new. Hillman (1982), (1989), Magee, Brock andYoung (1989) and Long and Vousden (1991) have shown that, under plausibleassumptions, a rational government reduces protection in response to a dete-rioration in the external terms of trade. This paper re-examines this finding.In particular, we show that it depends on the implicit assumption that importsare final goods. It turns out that a deterioration in the external terms of tradedue to an imported intermediate input price shock increases protection. Thus,the relationship between the external terms of trade, measured as the ratioof export to import prices, and commercial policy is ambiguous and dependson the sources of external price shocks. These results have important policyimplications. In particular, they suggest that periods characterized by fallingprimary commodity and oil prices, such as that from 1988 to 1992, will beassociated with trade liberalization.

As our second topic, we examine the relationship between exogenousgrowth and protection. Despite its policy importance, this issue has receivedlittle attention. This neglect is surprising given that growth and changes in theexternal terms of trade are formally equivalent. In Section 4, we exploit thisequivalence to show that over the long run growth leads to trade liberalization.This means that the positive correlation between growth and outward lookingtrade policies assumed in the literature is also explainable in terms of a causa-tion running from exogenous growth to trade liberalization.2 Put differently,our findings suggest that trade liberalization is as much a consequence ofeconomic success as a cause of it. Finally, we show that our results withrespect to the effects of changes in the external terms of trade and growth onprotection hold for tariffs and quantitative restrictions.

This paper is organized as follows: in Section 2 we construct a model ofendogenous commercial policy formation. The next two sections present ourresults. Section 5 then extends the model to allow for quantitative restrictions.We give our concluding comments in the last section.

2. Commercial policy formation

Consider a small developing economy with two sectors: agriculture produc-ing food and an urban sector producing manufactures.3 Both goods are tradedand manufactures are protected by a tariff. Manufactures are produced usinglabor and a fixed stock of capital. In addition, we assume that tariff revenue,denoted by R, is rebated in lump sum fashion to the urban sector.4 We alsoassume that the labor force is fixed at unity in each sector and that workerscan vary their labor supply.

Equation (1) is the urban sector’s budget constraint.

45

PX1+ R= Px1+ y1 (1)

P is the domestic price of manufactures which is equal to (P∗+T), whereP∗ is the world price and T is the tariff. The lower case symbols y1 and x1are consumption of food and manufactures in the urban sector. We denotemanufacturing output by the upper case X1. Throughout, we use the agricul-tural good as ournuméraire. Therefore, P is the internal terms of trade ofmanufactures in terms of food.

The indirect utility function (V1) for the urban sector is given by (2).

V1(P,R) = Max U1(x1, y1)+ λ1(P(X1− x1)+ R− y1) (2)

This function is convex and homogeneous of degree one in prices. Fromthe envelope theorem,∂V1/∂P =λ1Q1 where Q1 = (X1-x1) is the excess sup-ply function of manufactures andλ1 is the marginal utility of urban income.We assume throughout that excess supply is positively sloped.

Farmers produce food using labor and a fixed supply of land. They con-sume food and manufactures. Their budget constraint is given by (3) whereY2 is food production and x2, y2 are consumption of manufactures and food.

Y2 = Px2+ y2 (3)

Equation (4) is the indirect utility function for the rural sector.

V2(P) = Max U2(x2, y2)+ λ2((Y2− y2)− Px2) (4)

Finally, tariff revenue is given by (5) where M, the volume of imports, isequal to (x2–Q1).

R= TM (5)

This model is the simplest general equilibrium framework that we couldcome up with to analyze the relationship between growth and changes in theexternal terms of trade on the one hand and commercial policy formation onthe other. But, as we shall emphasize later, our results hold in more complexmodels.

Following Hillman (1982) and Long and Vousden (1991), we model po-litical behavior using Peltzman’s (1976) model of policy formation. In thisapproach, the government uses commercial policy to maximize its politicalsupport which, in turn, depends on income in both sectors. Recently, Gross-man and Helpman (1994), building on work by Bernheim and Whinston(1986), have shown that the political support function can be derived from a

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formal game theoretic model of lobbying behavior.5 For our purposes, there-fore, the political support approach provides a simple yet powerful model ofthe political process.

The political support function, given in (6), states that political support(W) depends on the welfare of the rural and urban sectors.6 We assumethat this function is additive and strictly concave. This means that there arediminishing political returns to income transfers across sectors.7 It is thisassumption that gives rise to what Peltzman (1976), (1989) has describedas “wealth spreading behavior” where shocks to the real income of the i’thsector are spread by government policy over all sectors.8

W =W1(V1)+W2(V2) (6)

The government chooses the tariff which maximizes its political support.The first order conditions for this problem are given by (7). Formal details ofthe model are found in the appendix.

−β2x2+ β1Q1+ β1

(M + T

∂M

∂P

)= 0 (7)

Whereβ i = λ∂Wi/∂Vi is the increase in political support produced by anincrease in the income of a worker in sector i,λi is the marginal utility ofincome in this sector and∂M/∂P is the slope of the import demand functionfor manufactures. In the endogenous protection literature, theβ’s are polit-ical weights. From (7), we see that the politically optimal tariff equates theincrease in support from redistributing income to the urban sector to the lossof political support from rural producers. The tariff is thus determined by therelative political power of each sector as well as by the general equilibriumelasticity of import demand.9 For future reference, observe that the politi-cally optimal tariff can be above or below the revenue maximizing tariff. Tosee this, consider the case where the rural sector does not enter the politicalsupport function. Note from (7), that raising the tariff increases urban welfareuntil T = –x2/(∂M/∂P). This is clearly above the revenue maximizing rate ofprotection.

3. Commercial policy and the external terms of trade

In this section, we examine how a support maximizing government altersprotection in response to exogenous changes in the external terms of trade.We extend previous research in that we allow terms of trade shocks to arisefrom intermediate input as well as from final goods price changes. This is animportant extension because the imports of developing economies are dom-inated by intermediate commodities. UNCTAD data (UNCTAD (1990)), for

47

example, suggests that up to two thirds of imports for a typical developingeconomy are intermediate goods such as machinery and raw materials forwhich few domestic substitutes exist. In addition, the more restrictive thetrade regime the greater, in general, is the share of intermediates in imports.As we now show, a deterioration in the external terms of trade caused by anintermediate input price riseincreasesprotection thereby reversing previousresults in the literature.

To better understand the economic forces at work, we start by lookingat the effects on protection of an increase in the world price of manufactures.This is the question examined previously by Hillman (1982), (1989) and Longand Vousden (1991).

dT

dP∗= −1+M(λ1)

2W′′1(x2 + T ∂M

∂P )+ β1∂M∂P

1< 0 (8)

Equation (8) is obtained from (7). Further details are given in the appendix.The second order conditions are given by1. Using (8), we can show that thegovernment reduces the tariff in response to an increase in the world price ofthe import good. But the tariff is reduced by less than the world price increase.Therefore, part of the world price change is passed on to domestic producersand consumers as found by Hillman (1982), (1989) and Long and Vousden(1991), Magee, Brock and Young (1989). This result is consistent with empir-ical evidence on commercial policy. Tyers and Anderson (1992), for example,note that partial price insulation is a feature of trade policy in agriculturalmarkets for developing and developed economies. Finally, Eaton and Gross-man (1985), Cassing, Hillman and Long (1986) and Staiger and Tabellini(1987) have obtained similar findings in optimal tax models. Thus, “politi-cal support maximizing” and “welfare maximizing” governments respond inqualitatively similar ways to changes in the external terms of trade.

The intuition behind (8) is straightforward. An increase in the externalprice of manufactures reduces welfare in the rural sector and lowers tariffrevenue. The effects on urban welfare is, however, ambiguous. This is be-cause the direct effect of a world price increase, working through the higherinternal price of manufactures, raises urban welfare while the indirect effect,due to the fall in tariff revenue, lowers it.10 Clearly, the old tariff is no longeroptimal as the political weight of the urban sector falls relative to that of therural sector. To restore equilibrium, the government must transfer income tothe rural sector. The only way that this can occur in our model is through areduction in protection. In effect, the government uses commercial policy tospread the decline in rural income over both sectors.

In the new equilibrium with a lower tariff, welfare in the rural sector fallswhile welfare in the urban sector can rise or fall.11 Paradoxically, therefore,

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the urban sector can lose from an increase in the world price of its output.In addition, it can be shown that the higher is the initial level of protection,the more likely it is that urban welfare falls and the greater is the insula-tion afforded to domestic prices from external shocks. From (8), we see thatinsulation is never total however.

To incorporate intermediate inputs, we assume that an imported input “oil”is used in manufactures. We further assume that there are no restrictions onoil imports.12 With these modifications, the urban sector’s budget constraintbecomes PX1+R = Px1+y1+PoO where Po is the domestic price of oil and Oare oil imports.

Equation (9) solves for the effects of an oil price rise on protection.13 Thisexpression is obtained from the first order conditions. It is positive showingthat an oil price riseincreasesthe tariff.14

To understand this result, note that at a constant tariff the oil price risereduces urban welfare by increasing the cost of the inputs used to producemanufactures. This will increase the political weight of the urban sector. Bycontrast, the oil price increase does not change rural welfare. Clearly, the gov-ernment can increase its political support by transferring income from ruralproducers to the urban sector. This is accomplished by increasing protection.Once again, trade policy is driven by considerations of wealth spreading. Buthere wealth spreading requires that the government respond to a deteriorationin the external terms of trade by increasing protection.

dTdPo=

−[W′′1(λ1)2(x2+T ∂M

∂P )(T∂M∂P0−O)+W′1

∂λ1∂Po

x2(x2+T ∂M∂P )+β1T ∂2M

∂P∂Po

1> 0

(9)

With three goods, there are two relative prices in this economy. Let usnow consider the effects of a change in the world price of the agriculturalgood. Specifically, let us look at the effects of a fall in the world price ofagricultural exports. This is, by definition, equal to a simultaneous increasein the world prices of manufactures and oil. From this equivalence, and using(8) and (9), we can show that an export price fall leads the government toreduce protection. Intuitively, this occurs because the price shock increasesurban welfare while reducing that of the rural welfare.

To sum up, we have shown that there is no unique relationship betweenchanges in the external terms of trade, as conventionally measured, and pro-tection. Rather, information on the sources of external price shocks is neces-sary if we are to determine the effects of terms of trade changes on protection.

These results provide some insight into recent experience in the develop-ing world. It has been widely remarked that developing economies respondeddifferently to the external shocks of the early and late 1980s. In the first

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period, many countries increased protection. By contrast, protection was low-ered by most economies in response to the economic crises of the late 1980’s.These patterns of adjustment are consistent with the predictions of our model.Recall that in the early 1980’s commodity price falls were accompanied by oilprice increases. In these circumstances, the political support model suggeststhat protection can increase or fall. At the end of the decade, however, bothoil and primary export prices fell. In the latter case, the model predicts thatpolitical pressures for trade liberalization will intensify.

To conclude this section, let us outline the differences between intermedi-ate and final import price shocks with endogenous protection. First, commer-cial policy increases the variability of internal relative prices with importedinput price changes whereas it dampens them with final goods price shocks.Second, the higher is the initial level of protection, the smaller is the tariffchange for imported intermediate price changes. The opposite is the case forfinal goods price changes. Finally, an increase in the price of oil reduces wel-fare for the rural and urban sectors. For final goods price shocks, by contrast,income in the urban and rural sectors can move in opposite directions.15

4. Growth and commercial policy

Since Adam Smith, economists have studied the relationship between tradepolicy and growth. Recent theoretical work in this area shows that trade policycan affect both the level and the growth rate of income.16 To a large extent,this literature is a reaction to the empirical evidence, referred to earlier, whichshows that outward looking trade policies are accompanied by higher rates ofgrowth. It is taken for granted in the literature that causation runs from tradepolicy to economic performance. In this section, by contrast, we examine theeffects of exogenous growth on trade policy. With the exception Devereux(1992), we are aware of no previous work in this area.17 We demonstrate thatendogenous models of protection generate the observed positive correlationbetween trade reform and growth but where growth precedes liberalization.

From Bhagwati (1973), we know that growth and changes in the externalterms of trade are formally equivalent. In fact, extending the model to allowfor growth requires only slight modifications. For simplicity, we assume thatgrowth is due to sector specific Hicks neutral technological progress. Fromthis assumption, the production functions for each sector are given by X1

= αX(.) and Y2 = θY(.) respectively whereα andφ are indices of sectoraltechnology. For future reference, recall that Hicks neutral technical progressis equivalent to an output price increase. We choose units so that∂X1/∂P =∂X1/∂α.

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Let us begin by looking at the effects of urban sector growth on protection.This is given by (10). At a constant tariff, such growth is anti-trade biasedbecause it reduces imports and lowers tariff revenue. Growth increases urbanwelfare while rural welfare is constant. Consequently, the relative politicalweight of the urban sector must rise. As shown by (10), the governmentreduces protection to restore equilibrium in the political market. Once again,we find that commercial policy spreads an increase in income accruing to onesector over all sectors.18

dTdα =−[W′′1(λ1)

2(x2+T ∂M∂P )(X1+T ∂M

∂α )+W′1∂λ1∂α (x2+T ∂M

∂P )+β1T ∂2M∂P∂α ]

1< 0

(10)

Next, let us examine the effects on protection of growth in the rural sector.This is given by (11). Growth in this sector is pro-trade biased since, at a con-stant level of protection, exports and tariff revenue increase. In fact, welfare inboth sectors must rise. For plausible parameter values, however, the politicalweight of the urban sector increases relative to that of the rural sector. In thissituation, we would expect protection to rise so as to transfer income to theurban sector.

dTdθ = −[−W′′2(λ2)

2x2Y2−W′2∂λ2∂θ

x2+ (β1− β2)∂x2∂θ]/1

−[W′′1(λ2)2(x2+ T ∂M

∂P )(T∂M∂θ+W′1

∂λ1∂θ)+ β1

∂2M∂P∂θ ]/1 > 0

(11)

To sum up, we find that the impact of growth on trade policy depends onsectoral patterns of growth. Growth in the rural sector will increase protectionwhile growth in the urban sector will reduce it. As the patterns of growthvary over the short term, there is thus unlikely to be a simple relationshipbetween growth and commercial policy over this time period. Experienceteaches us, however, that over the longer run technological progress occurs ata faster rate in manufacturing and services which constitute the urban sectorin developing economies. For example, the World Bank (World Bank (1993))estimates that over the 1980–1990 period growth in manufacturing and ser-vices for the low income economies (excluding China and India) averaged6.8 and 4.8 per cent. By contrast, agriculture grew at only 2.5 per cent. Fromthis, it follows that there is a presumption that growth will eventually lead totrade liberalization. Thus, our model generates a positive correlation betweenoutward looking trade policy and growth but with a causation opposite to thatusually assumed. Moreover, this result provides a theoretical basis supportfor empirical studies, such as Jung and Marshall (1985), that find causationrunning from growth to openness.19

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If growth in the urban sector exceeds that in the rural sector, the economyeventually exports manufactures. In this case, it can be shown that protectionshifts to the rural sector. Thus, our model is consistent with the stylized factsof East Asian economies such as Japan, Korea and Taiwan where growth,within a generation, transformed previously taxed agriculture into a protectedsector.20

Moreover, we have ignored other avenues through which growth reducesprotection. Most notable of these is the fact that growth raises the efficiencyof domestic taxes and subsidies relative to commercial policy. This will rein-force the positive correlation between growth and trade policy noted above.21

5. Tariffs and quotas

Until now, we have assumed that protection is by means of a tariff. For manydeveloping economies, quantitative restrictions such as quotas, licences andforeign exchange rationing are more prevalent than tariffs. With exogenoustrade policy, it is well known that the welfare effects of growth and changes inthe external terms depend on whether tariffs or quotas are used. It is thereforeimportant to investigate whether our findings hold with quantitative restric-tions. Fortunately, this indeed turns out to be the case.

Let us assume that imports are restricted by a quota, denoted byM, asshown in (12).

M = x2−Q1 (12)

We further assume that the quota is auctioned off competitively, that rev-enue is returned to the urban sector in lump sum fashion, that there is perfectcertainty and that manufacturing is competitive.

Maximizing political support, given by (6), with respect to a quota, thefollowing first order conditions are obtained. Recall that P∗ is the world priceand that (P-P∗) is equal to the implicit tariff generated by the quota.

[−β2x2+ β1Q1+ β1(M + (P∗ − P)∂M

∂P][ dP

dM] = 0 (13)

The term within the second square brackets in (14), dP/dM, the change inthe domestic price of manufactures due to a change in the quota, is negative.Consequently, the terms within the first square brackets must equal zero fora maximum. But these are just the first order conditions for the politicallyoptimal tariff, given by (7). We conclude, therefore, that the implicit tariffassociated with this quota is equivalent to the politically optimal tariff givenin (7). Consequently, the level of protection in this economy does not depend

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on whether a tariff or a quota is used.22 From this equivalence, it follows thatthe results of the previous two sections hold for quantitative restrictions aswell as for tariffs.

6. Concluding comments

We have developed a model which focuses on growth and changes in theexternal terms of trade as determinants of commercial policy. Our centralmessage in this paper is that positive models of protection can explain whytrade liberalization occurs simultaneously in countries with different eco-nomic and political structures without resorting to exogenous changes inpolitical preferences or pressures from external organizations. Our results canbe summarized by two propositions: first, the relationship between changesin the external terms of trade, as usually measured, and protection dependson the sources of external price shocks. A deterioration in the external termsof trade due to a final import price increase will reduce protection while adeterioration in the external terms of trade due to an increase in the price ofan imported input raises it. Second, exogenous growth reduces trade barriersin the long run. This, in turn, generates a positive correlation between open-ness and growth. Finally, these results hold for tariffs and for quantitativerestrictions.

Our model is limited, however, in that it ignores factor mobility. In ad-dition, there is no domestic production of the imported intermediate good.To conclude, we shall sketch how our results generalize to more complicatedmodels. We use the two sector Specific Factor and Heckscher Ohlin modelsas our examples.23 Long and Vousden (1991) and Magee, Brock and Young(1989) have shown that protection is reduced in response to an increase inthe world price of the protected good in the sector specific and HeckscherOhlin models respectively so this need not concern us. To start, let us ex-amine the effects of an imported oil price increase in the Heckscher Ohlinmodel. Assuming that manufactures use oil and capital intensively relative toexportables, this external price shock reduces the real return to capital andincreases the real wage rate. It is easy to show that a support maximizinggovernment will then increase protection. The situation is more complicatedwhen we come to the Specific Factors model. Here we have to make strongerassumptions to obtain our results. Assume that the economy produces twogoods, manufactures and food, and that each sector uses a specific factor“capital” and an economy wide mobile factor “labor”. Further, let us as-sume that manufactures use imported oil. Under standard assumptions abouttechnology, an intermediate price increase raises the return on capital in agri-

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culture and reduces that in manufactures. For plausible parameter values, thiswill increase protection.

In models with constant returns to scale, growth is due to factor accu-mulation and technological progress. Fortunately, our results with regard totechnological progress also hold in the Heckscher Ohlin and Specific factorsmodels. Indeed, they are strengthened in the Heckscher Ohlin case. But factoraccumulation poses problems for the political support approach. To see why,let us consider the effects of an increase in the labor force. Recall, that in thepolitical support approach the political weight of a group depends on its sizerelative to other groups (see Peltzman, 1976). As is well known, an increasein group size could increase or reduce political power. The effects of factoraccumulation on commercial policy are thus ambiguous.

Notes

1. Moreover, the empirical evidence, as summarized in Haggard and Webb (1993), suggeststhat international organizations have limited ability to change the policies of developingeconomies.

2. There is an impressive body of evidence that export promotion, defined as policies whichprovide neutral trade incentives, is associated with higher rates of growth see Bhagwati(1988), Edwards (1992) and Knight, Loayza and Villanueva (1993). Bhagwati (1988)emphasizes, however, that outward looking policies are consistent with a high degree ofgovernment intervention.

3. This model draws on that of Sah and Stiglitz (1984). In addition, the Grossman andHelpman (1994) model has similarities with ours in that they characterize the politicallyoptimal level of protection in terms of import demand and export supply functions, seealso Krugman (1993).

4. We differ in this assumption from other papers in the endogenous protection literaturewhere it is assumed that tariff revenue is rebated lump sum to all agents in the econ-omy, see for example Mayer (1984) and Grossman and Helpman (1994). Fortunately, ourresults in this paper do not depend on how tariff revenue is distributed. But with morethan two sectors, or with mobile factors as in Long and Vousden (1991), the distributionof tariff revenue is crucial. For a further discussion of this issue see Long and Vousden(1991), Hillman (1988) and Rodrik (1994).

5. Rodrik (1994) surveys previous trade applications of the political support approach. Tothe best of our knowledge, Long and Vousden (1991) is the only other paper to use thepolitical support function in a general equilibrium model.

6. We follow Long and Vousden (1991) in this assumption. Hillman (1982) who started thisstrand of the literature assumed, by contrast, that political support depends on the diver-gence of income in each sector from its free trade level. This assumption complicates thecomparative statics without changing the nature of the economic forces at work. As men-tioned previously, Grossman and Helpman (1994) have shown that the Long and Vousdenversion of the political support function has rigorous microeconomic foundations.

7. Dougan (1981) and Long and Vousden (1991) assume that the political support functionis a linear additive function of its arguments. In our model, the linearity assumption leadsto problems with second order conditions.

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8. Or, as stated by Hirshleifer (1976), share the pain, share the gain. Interestingly, this is alsoa property of the Conservative Social Welfare function proposed by Corden (1974).

9. This result was obtained in a slightly different form by Dougan (1981). In addition, it isrelated to that of Grossman and Helpman (1994) who refer to their findings as a modifiedRamsey rule. Also, as Lerner Symmetry holds in our model, it is irrelevant whether weconsider an import tariff or an export tax.

10. Using equation (1), the impact on urban income equals [Q1 + T∂M/∂P]. From this wecan see that the decline in rural income is always greater than that in urban income.

11. We assume that the initial tariff is high enough to allow the government to offset the effectsof changes in the external terms of trade on internal relative prices using commercialpolicy if it so desires.

12. Intermediate inputs complicate the model since there are two relative prices. Therefore, atariff on final imports is no longer equivalent to an export tax. It can be shown, however,that an oil tariff is politically sub-optimal as it lowers political support. In general, thepolitically optimal commercial policy requires that the tariff on manufactures be combinedwith an export tax. Export taxes complicate the model without changing our results andare therefore ignored.

13. We assume that an increase in the price of oil raises the marginal utility of income inthe urban sector. Note also that the final term in the numerator of (9) refers to the factthat the oil price increase alters the slope of import demand. Throughout, we assume thatsuch terms are negative or zero. Even if this term is positive, it requires an implausiblecombination of parameter values for protection to increase.

14. Note that we have implicitly assumed here that the welfare reducing direct welfare effectof a higher oil price dominates the indirect welfare effect of increased tariff revenues, inother words that(T∂M/∂po −O) < 0.

15. If oil is produced domestically, the welfare of oil producers enters the political supportfunction and the effects of an oil price rise on protection are uncertain. Nonetheless,as long as manufactures use oil intensively relative to the rural sector, an oil price riseincreases protection for plausible parameter values because it shifts income from the urbansector to oil producers.

16. An early paper is Krugman (1988). Especially important in this area is Helpman andGrossman (1991).

17. Devereux (1992) studies the effects of growth on trade liberalization using a non-politicalmodel of a tariff game between two governments. We are indebted to our referee for thisreference.

18. Note to ensure this we have to rule out immiserizing growthá la Johnson’s (1967). Thus,we assume that the(X1+ T∂M/∂P) term is positive.

19. Along the same lines, Trela and Whalley (1992) have used a computable general equilib-rium model to argue that trade policy cannot explain Korea’s rapid growth.

20. Anderson and Hayami (1986) estimate that nominal protection in 1955 for agriculturein Korea and Taiwan was –46 and –17 percent respectively. By 1980, this industry wasreceiving protection of 117 percent in Korea and 52 percent in Taiwan.

21. Gardner and Kimbrough (1992) model this process.

22. This result is related to Sweeny, Tower and Willett’s (1977) finding that tariff and quotasare equivalent with monopoly so long as the monopolist knows the governments objectivefunction.

23. For details on the formal structure of such models see Rodrik (1994).

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Appendix

In this appendix, we sketch how the main results of the paper are obtained. Fullderivations are available on request from the authors.

To obtain equation (7) in the text we first maximixe (6) with respect to the tariffand we obtain (1a).

W′1 V1T+W′2 V2T = 0 (1a)

Where ViT is the derivative of the i’th sectors indirect utility function with respectto the tariff. Then, applying the envelope theorem and recalling that tariff revenueis rebated lump sum to the urban sector, yields (7) in the text. To proceed, it isconvenient to rewrite the first order conditions (7) as:

−β2x2+ β1(x2+ T∂M

∂P) = 0 (2a)

The second order conditions,1, are given by (3a). We assume that the marginalutility of income in manufacturing declines with increases in the external terms oftrade while that in agriculture increases. This ensures that second order conditionsare satisfied.

1 = W′′2(λ1x2)2−W1

2∂λ1∂P + (β1− β2)

∂x2∂P +W′′1(λ1(x2+ T ∂M

∂P ))2

+W′1∂λ1∂P (x2+ T ∂M

∂P )+ β1(∂M∂P = T ∂

2M∂P2 ) < 0

(3a)

To obtain (8), which gives the effect of a change in the external terms of tradeon protection, we totally differentiate (2a). Note that the numerator and denominatorin (8) differ due to the fact that the income effects associated with a change in theexternal terms of trade are different from those due to protection.

To obtain (9), which gives the effects of an increase in the world price on pro-tection, we totally differentiate (7) with respect to the price of oil on protectionand we use the fact that, V1o, the derivative of the indirect utility function of themanufacturing sector with respect to the price of oil is (−O+ T∂M/∂Po). To obtain(10) and (11), note that V1α = (X1 + T∂M/∂a) and that V1θ=Y2.