stoyanov (2009)_trade policy of a free trade agreement in the presence of foreign lobbying

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Trade policy of a free trade agreement in the presence of foreign lobbying☆

Andrey Stoyanov ⁎

Economics, Atkinson Faculty of Liberal Arts and Professional Studies, York University, 2009-4700 Keele Str., Toronto, ON, Canada

a b s t r a c ta r t i c l e i n f o

Article history:

Received 14 April 2008

Received in revised form 7 October 2008

Accepted 8 October 2008

Keywords:

Trade policy

Free Trade Areas

Foreign lobbies

JEL classi cation:

F12

F13

F14

D72

This paper studies the effect of foreign lobbies on trade policy of a country which is a member of a Free Trade

Agreement (FTA). It uses a monopolistically competitive political economy model in which the government

determines external tariffs endogenously. The effect of foreign lobbying under the FTA is examined

empirically using Canadian industry-level trade data that allow differentiating of lobby groups by the countryof origin. The analysis suggests that the presence of foreign lobbying has a signicant effect on the domestic

trade policy. The heterogeneity of foreign lobbies is also important: the presence of an organized lobbying

group in an FTA partner country tends to raise trade barriers while an organized lobbying group of exporters

from outside of the FTA is associated with less protection.

© 2008 Elsevier B.V. All rights reserved.

1. Introduction

In the political economy literature a growing number of studies

view trade policy as an endogenous outcome of lobbying activity byspecial interest groups. Several authors (Goldberg and Maggi, 1999,

Gawande and Bandyopadhyay, 2000) have conrmed that lobbying

intensity by domestic rms is one of the main determinants of the

cross-industry pattern of protection. More recently, Gawande et al.

(2006) also nd that lobbying by foreign rms for trade barriers

reduction has a signicant effect on the structure of tariffs across

industries. However, if a country is a member of a regional free trade

agreement (FTA) and foreign rms can affect the government's

decision regarding trade policy, it becomes necessary to distinguish

foreign lobbying from within and outside of the FTA. Organized

foreign interests with preferential market access will lobby for more

protection against other foreign rms, and the trade agreement may

become more protectionist with a strong lobby group in a prospective

FTA partner country. Active foreign lobbying under the preferential

trade agreement may not only lead to an increase in trade barriers, but

also make welfare-reducing trade agreements politically feasible.

In this paper I analyze the effect of foreign lobbying on domestic

trade policy when the country is a member of a preferential trade

agreement using Canadian post-NAFTA trade data. This analysis

reveals two main results. First, the activity of foreign lobbyists in

Canada is a signicant determinant of the Canadian trade policy, and

sectors in which foreign rms without preferential market access are

politically organized tend to receive less protection. This result

supports the previous nding by Gawande et al. (2006) for the US.

Second, NAFTA has an important effect on the structure of foreign

lobbies. The data conrm that foreign rms with preferential market

access lobby for more protection just as domestic rms do. This result

hasimportant implications forthe effectof an FTA on a country'strade

policy. It implies that prior to NAFTA, US rms lobbied for Canadian

trade barriers reduction like all other foreign rms, but once NAFTA

was signed, they switch to lobbying for trade barriers increase. As a

result, an FTA with a large and politically strong partner country mayraise trade barriers and increase trade distortions, making trade policy

of regional trading blocks more protectionist.1

Journal of International Economics 77 (2009) 37–49

☆ I am grateful to my advisors Werner Antweiler, Matilde Bombardini and Brian

Copeland for continuous support and guidance. I am also grateful to Christopher

Barrington-Leigh, Kishore Gawande, Vadim Marmer, and Daniel Treer for useful

discussions on the topic. I also would like to thank seminar participants of the

University of British Columbia, McMaster University, New Economic School, Ryerson

University, Syracuse University, University of Toronto, York University, University of

Victoria, 2007 European Econometrics Society Summer Meetings, and Canadian

Economic Association conference for their comments and suggestions.

⁎ Tel.: +1 416 736 2100x22833; fax: +1 416 736 5188.

E-mail address: [email protected].

1 Two considerations should be taken into account when partner country lobbying

for more protection is considered. First, the W TO tariff binding constrains the lobbying

opportunities by the partner country rms; however, they may still play an important

role in the future and impede multilateral trade liberalization in those sectors. Second,

the WTO precludes countries from raising their tariffs once the FTA is signed. Yet

foreign lobbies may oppose further tariff reduction as described above and use anti-

dumping and countervailing measures to gain protection.

0022-1996/$ – see front matter © 2008 Elsevier B.V. All rights reserved.

doi:10.1016/j.jinteco.2008.10.001

Contents lists available at ScienceDirect

Journal of International Economics

j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / e c o n b a s e

mailto:[email protected]://dx.doi.org/10.1016/j.jinteco.2008.10.001http://www.sciencedirect.com/science/journal/00221996http://www.sciencedirect.com/science/journal/00221996http://dx.doi.org/10.1016/j.jinteco.2008.10.001mailto:[email protected]


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headquarters, if there is one. An amendment to the LRA, introduced in

1996, made this information publicly available. It also introduced a

strict disclosure of funds policy applied to political parties. Together

with the Canada Elections Act, the LRA made it dif cult for foreign

rms to lobby their interests in Canada directly.

Nevertheless, politically active foreign rms can still inuence

trade policy outcomes in at least two ways. First, they can hire

Canadian agents and consultants to lobby the executive branch on

their behalf andaffect policyoutcomesin a way that suits theinterestsof foreign rms. Second, subsidiaries of foreign enterprises can make

legal political contributions with their own funds to defeat legislators

who areunfriendly to their interests. Since there areno restrictions on

the share of foreign capital in the assets of a company that makes

political contributions, any local subsidiary of a foreign corporation

can make political donations from its own funds if “it carries business

in Canada.” Moreover, almost any big foreign company that exports to

Canada has an independent local sales department, which is legally

allowed to lobby for a reduction in trade barriers on the products

imported by its parent company into Canada. Lobbying efforts of such

subsidiaries will be counter to the efforts of domestic rms and,

therefore, pooling all Canadian rms together regardless of their

ownership may lead to misleading results and estimation problems.

In the trade policy literature, corporate political activity is typically

measured by nancial contributions to candidates and political parties,

while verylittle attentionhas beenpaid to othermeans of affecting policy

outcomes such as direct lobbying. However, earlier research on the effect

of foreign companies on national policy (Hansen and Mitchell, 2000)

suggests that foreign corporations prefer direct lobbying to political

contributions not only because of legal restrictions on contributions, but

also because of informal legitimacy questions for politicians with respect

to accepting money from corporate sources with foreign ownership.

Hansen and Mitchell found that because lobbying is less visible than

contributions, foreigners use it as intensively (and effectively) as

domestic rms do. For these reasons, lobbying expenditures seem to be

a better measure of foreign political involvement, especially in countries

with legal restrictions on political contributions by foreigners.

Unfortunately, data on lobbying expenditures by domestic and

foreign corporations are unavailable for Canada. To illustrate the roleof this channel in foreign political activity in Canada, I collected the

information on the number of lobbyists of cially registered with the

Of ce of the Registrar of Lobbyists, as is required by the LRA. 3 The

lobbyists registration data is publicly available and is discussed in

more detail in Section 4.2, but the following gures demonstrate the

relative importance of foreign lobbying in Canada. In 1996–97, there

were 1032 of cially registered lobbyists representing interests of

manufacturing rms regarding Canadian trade policy, with 47%, 26%

and 27% of them acting on behalf of Canadian, US and ROW rms,

respectively. These gures highlight the potential strength of foreign

lobbyists in Canada and suggest that the numberof contacts of foreign

rms with Canadian policymakers was at least not smaller than that of

domestic rms. Then, when almost every country in a world trades

under preferential agreements, it is important to consider the effect of foreign lobbying under the FTA when a group of foreign rms with

preferential market access may lobby for more protection and

reinforce trade diversion effects.

3. The model

The theoretical model is based on the Grossman and Helpman

(1994) political economy model and presents several modications

that allow for the presence of foreign lobbying and facilitate

econometric estimation. In their original formulation, Grossman

and Helpman considered a small open economy, which leaves no

room for foreign companies to lobby because pre-tariff prices are

exogenously xed. As such, with perfectly competitive global

markets and free entry, an increase in the domestic tariff rate will

not affect prots of foreign rm from export operations, leaving

them no incentives to participate in trade-policy game. In this work I

develop and build into the GH setup a model of monopolisticcompetition with differentiated goods4 to allow foreign rms to gain

or lose from import tariffs.5

There is 1 industry in the model and three countries: Canada

(Home country), the US (FTA Partner country) and the ROW, denoted

by H , P and ROW, respectively. Industries are denoted by index

i∈{1,…, N } and countries by i∈ {H , P , ROW}There are ni jrms in

country j and industry i . These rms are assumed to be symmetric

within the same country and industry, i.e. they share the same cost

structure and hence face the same demand functions and charge the

same prices. In total, there are (niH + ni

P + niROW ) different varieties of

each product i .

A representative consumer maximizes a quasilinear utility func-

tion with a constant elasticity of substitution index nested into a

Cobb–Douglas function:

U = X 0 + ∑N

i = 1

ω iln X i

X i = nH i d

H 1σ i

i xH σ i−1σ i

i + nP i d

P 1σ i

i xP σ i−1σ i

i + nROWi d

ROW1σ i

i xROW

σ i−1σ i

i

! σ iσ i−1

ð1Þ

where X i is an aggregate consumption index for product i , ω i is the

share of product i in the total consumer's expenditure, xi j is the

demand for product i produced in country j, σ iN1 is the elasticity of

substitution between varieties of product i, and di j is a country-wide

taste (or quality) parameter for product i imported from country j.

Maximizing Eq. (1) subject to the standard budget constraint, we

obtain the demand functions and an aggregate price index for

product i:

X i = ω i P ið Þ−1

; iz1 ð2Þ

x ji = ω id

ji

p ji

p ji

P i

!1−σ ið3Þ

P i = nH i d

H i p

H i

1−σ i+ nP i d

P i p

P i

1−σ i+ nROWi d

ROWi p

ROWi

1−σ i 11−σ i ð4ÞFirms within one country and sector areassumed to have the same

constant marginal cost. This allows us to consider the Canadian

market independently from other markets, i.e. prices in the Canadianmarket depend only on the demand elasticity, the (xed) number of

rms and the xed marginal cost structure. Denoting a specic import

tariff set by the home country government on imports of product i

3 The Act denes a lobbyist as “an individual who, for payment, undertakes to lobby

on behalf of a client” and represents an organization in arranging meetings with public

of ce holders, or “communicate with a public of ce holder in an attempt to inuence

the development of any legislative proposal, …the making or amendment of any

regulation, …the development or amendment of any program or policy.”

4 The model developed in this section is a generalization of the GH model with

monopolistic competition by Chang (2005) that allows for country bias in consumers

preferences, country-specic productivity and specic import tariff.5 Similar result can be obtained under other forms of imperfect competition, e.g.

oligopoly, but the advantage of monopolistic competition is that trade policy is

determined by the shares of domestic and foreign rms on the home country market.

In general, market shares are more stable than inverse import penetration ratios

required by the model of perfect competition (Grossman and Helpman, 1994) or

oligopoly (Gawande et al., 2006).

39 A. Stoyanov / Journal of International Economics 77 (2009) 37 –49


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from country j as τ i j, we can write the prot of a country j rm that

sells product i in the Canada as:

π ji = p

ji −c

ji−τ

ji

q ji ð5Þ

where qi j is the quantity supplied and c i

j is the marginal costs. I assume

that the number of rms is large enough to ignore the effect of their

individual pricing decisions on the industry price index P i, i.e. each

rm takes the price index as given. Knowing product demand

functions (3), each rm sets the prot-maximizing price as a markupover its marginal costs:

pH i = σ iσ i−1

c H i ; p

P i =

σ iσ i−1

c P i + τ

P i

; pROWi =

σ iσ i−1

c ROWi + τ

ROWi

ð6Þ

For convenience, isolate costs from Eq. (6) and write down

equilibrium prots (5) as:

π ji = σ −1i p

jiq j

i ; 8 j ð7Þ

The government chooses import tariffs to maximize a weighted

sum of national welfare W and political contributions C :

G τ j

;

C

j = ∑i C

H

i + aW + b∑i C

P

i + c ∑i C

ROW

i ð8Þ

where C iH , C i

P and C iROWare industry-wide political contributions from

each country. Coef cient a is a weight that the government assigns to

national welfare relative to political contributions. The government is

allowed to value domestic and foreign contributions differently as

reected by parameters b and c that show the government's

preferences for the US and ROW contributions, respectively, over the

contributions by domestic rms. As long as accepting contributions

from foreign rms involves risk of reputation loss or law infraction,

politicians may prefer domestic contributions to overseas donations

thus both coef cients are presumably less or equal to one.6

Firms in industry i can organize themselves and form a group to

lobby the local government for a change in trade policy.7 Firms within

the FTA pay no import tariffs and hence lobby for more protection,while rms from other countries lobby for lower tariffs for the

opposite reason. The lobby representing industry i of country j

maximizes its welfare from obtaining protection net of political

contribution: (W i j−C i

j). As in Grossman and Helpman (1994), the

equilibrium trade policy is a solution to a two-stage game. In the rst

stage, knowing the government's objective function, each organized

lobbying group provides the government with a schedule of political

contributions as a function of import tariff. In the second stage,

observing contribution schedules, the government sets trade policy

that maximizes its objective function (8). Grossman and Helpman

(1994) show that for truthful contribution schedules theoptimal trade

policy is the one that maximizes joint surplus of the government and

organized lobbying groups. Let α i denote the share of the home

country population entitled to the domestic industry i prots, and I i j

denotean index variable that takes thevalue of onewhen industry i in

country j is politically organized and zero otherwise. The joint welfare

function then takes the form:

X = ∑N

i = 1

I H i W H i + aW + b ∑

N

i = 1

I P i W P i + c ∑

N

i = 1

I ROWi W ROWi ð9Þ

where W iH = ni

H τ iH +α i (TR+CS) is welfare of the domestic industry i

gross of political contributions, TR and CS are total tariff revenue and

consumer surplus, respectively, W i j= ni

jτ i j j∈(P, ROW) is gross welfare

of foreign industries i from exports to the home county market, andW =∑i (ni

H τ iH )+ TR+ CS is national welfare. Taking the rst order

conditionof thejoint welfare functionwith respect to theROW import

tariff rate and rearranging it, one obtains the expression for the

equilibrium trade policy:

ei

τ ROWi pROWi

= − 1

σ i+ σ i−1ð Þ

τ P i pP i

sP i + a

a + α

σ i−1

σ isH i +

1

a +α

σ i−1

σ iI H i s

H i +

+ bI P ia +α

σ i−1

σ isP i +

cI ROWia + α

σ i−1

σ isROWi −1 ð10Þ

where s ji = n j

i p j

i x j

i

P i X idenotes the share of country j rms on the Canadian

market for product i at the tax-included prices. On the left-hand side

of Eq. (10), (τ iROW/ pi

ROW) is the ad-valorem tariff on the ROW imports,

which is multiplied by the price elasticity of demand for the ROWimports ε i. Therefore, as in the benchmark GH model, trade protection

is inversely related to the import demand elasticity.8 The rst term on

the right-hand side is negative: the model predicts that with more

differentiated varieties will receive import subsidy. This result is a

direct consequence of monopolistic competition model with specic

import tariff.9

The second element on the right-hand side shows the positive

relation between the FTA external and internal tariffs and, following

Bagwell and Staiger (1997), reects a tariff complementarity effect: if

the tariff rate for the partner country is high, it is optimal for the

government to raise the external tariff as well. Intuitively, an increase

in the within-FTA tariff rate causes a decline in imports from the ROW,

and tariff revenue collected on the ROW imports is higher for higher

τ ROW. This, in turn, raises imports from the partner country, that

generates more tariff revenue for higher partner country tariff rate.

The tariff complementarity effect is proportional to the market share

of the partner country rms siP and is stronger if the partner country

and the ROW exports are close substitutes.

In contrast to the benchmark case, even for unorganized industries

protection may still be positive due to the imperfectly competitive

market structure, as emphasized by the third term, since the

coef cient aa + α

is positive. Because the share of domestic rms on the

market reects their ability to capture protection benets, and the

tariff is more effective in re-distributing consumers expenditure

towards domestic varieties when substitution elasticity is high, the

tariff level is proportional to siH and increasing with σ . The fourth term

is similar to the benchmark GH model: a politically organized

domestic industry receives more protection from the government.

Moreover, the level of protection is higher if domestic and importedvarieties are close substitutes and if the domestic sector is relatively

large, as the domestic lobby has more to gain from protection in this

case.6 In this simple model it is assumed that the government only values national

welfare and political contributions. However, politicians are also concerned about

political risk from being involved in relationships with foreign agents. If politicians

want to minimize the risk of being disclosed in protecting interests of foreign residents

and this risk is proportional to the amount of foreign contributions, the model can

generate different valuation of political contributions from different sources by

policymakers. Therefore, without modeling political risk explicitly, we can assume that

the government may have a political bias against foreign monetary contributions.7 With the number of rms in the sector being limited by the endowment of sector-

specic capital, rms in each industry have an incentive to form a lobby group and

seek for protection from foreign competition. Here I ignore the free-riding problem

within each sector. See Bombardini (2008) for an extensive discussion of rm-level

contribution decision.

8 It should be noted that without the MFN rule, a set of equilibrium tariffs for all

importers would be determined by a system of simultaneous equations with the

number of equations being equal to the number of importing countries. With the MFN

and the FTA, the number of equations goes down to two. However, under complete

trade liberalization agreement, a within-FTA tariff is exogenously set to zero and the

second term on the right-hand side of (10) vanishes.9 In the model of monopolistic competition, the effect of a specic tariff on price is

amplied by producer's markup. Therefore, for low σ the price elasticity with respect

to tariff is high and the gain in consumer surplus from a subsidy outweighs the

increase in government's expenditure.



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The fth term reects the effect of political activity by partner

country rms on the national trade policy. I i p enters the equation

positively, making protection more likely in those sectors where

partner country exporters are organized into lobbying groups and

where product varieties are closer substitutes. Similarly to the

domestic lobby, the effect of partner country rms lobbying on the

import tariff is proportional to their market share.

The last term is negative and reects the effect of lobbying efforts

bythe ROW

rmsto reduce protection. As before, thescaling factor

σ i−1

σ i

reects higher motivation by the ROW rms to lobby for trade

liberalization when the degree of substitution between varieties

within a given industry is high, but unlike domestic and partner

country lobbying, the ROW lobbying intensity declines with the

market share. The intuition behind this result is an increased damage

from protection for small ROW industries, and as a consequence these

industries will resist tariff increase more intensively.10

As in the GH model, domestic and partner country's lobbying

results in overprotection and welfare reduction relative to the rst-

best outcome. The presence of an organized foreign lobby from the

ROW may help to (partially) restore the optimal level of import tariffs

and raise national welfare as a counter pressure to domestic or US

lobbying for protection. However, the presence of the ROW lobbying

alone causes underprotection and is thus welfare-reducing. Given that

the number of politically organized domestic or US industries is on

average twice of the number of organized ROW industries, the overall

neteffect from thepresence of thepartner country lobbyingis likely to

lead to welfare reduction, whereas the overall welfare effect of the

ROW lobbying activity is unambiguous: the effect is positive if ROW

rms counter-lobby against the effort of domestic and partner country

rms to raise protection and negative if ROW rms form a single

organized lobbying group in the sector.

Eq. (10) motivates the following form of the estimation equation:

Y i = β 0 + β 1sH i + β 2I

H i s

H i + β 3I

P i s

P i + β 4I

ROWi 1−s

ROW i

Y i =

σ iσ i−1

ei

τ ROWi pROWi

+ 1

σ i

! ð11Þ

β 1 = a

a + α ; β 2 =

1

a + α ; β 3 =

b

a +α ; β 4 = −

c

a + α ð12Þ

In Eq. (10) the inverse elasticity was taken on the left-hand side

and both sides were multiplied by σ iσ i−1

because substitution elasticity is

likely to be measured with error. Using Eq. (12), the four coef cient

estimates of the reduced form (11) can be used to derive four

structural parameters of the model.

4. The data

The empirical section of this paper estimates the effects of

domestic, partner country and ROW lobbying activity on the Canadian

post-NAFTA trade policy. Given the relative size of the US andCanadian economies, the effect of US lobbying in Canada will be

considerably larger than the effect of Canadian lobbying in the US.

Therefore, focusing on Canadian data is particularly advantageous for

the empirical analysis of foreign lobbying under the FTA. This study is

conducted for 249 Canadian 6-digit NAICS manufacturing sectors

(NAICS 31–33) for the period of 1996–97. The US was treated as a

Canadian FTA partner country, while all other countries that have no

preferential trade agreements with Canada were aggregated into

ROW.11 The estimation of Eq. (10) requires the following data: the

measure for trade protection, imports by the country of origin and by

sector, domestic output by sectors, substitution and price elasticities,

political organization dummies, and three sets of instruments for

market shares.

4.1. Protection measures and market shares

Domestic manufacturing shipments data for 249 NAICS-6 indus-

tries areprovided by Industry Canada. Thevalues of Canadian imports,

as well as customs duties collected, were obtained from Statistics

Canada at the HTS-10 level and aggregated to NAICS-6 using the

concordances tables from the International Trade Division of Statistics

Canada.

Primarily, I use two measures for trade barriers: import tariffs and

the share of imports that is subject to non-tariff trade restrictions.

Although the original GH model was meant to analyze the political

economy of import tariff formation, tariff rates are often argued to be

an imperfect measure of trade protection for the analysis of

endogenous trade policy formation in the presence of WTO tariff

regulation. With limitations on the magnitude of tariffs imposed by

the WTO, organized interests would seek non-tariff protection from

import competition that are adopted unilaterally by different

countries, as opposed to tariffs that are set cooperatively in WTO

negotiations. Nevertheless, I use tariffs as a second measure of

protection. Even in the presence of WTO tariff regulation, tariffs can

still reect lobbying activity of Canadian and US interest groups

through smaller (larger for ROW lobbying) tariff reductions during

WTO negotiations that take place after trade agreement is signed. If

the government takes interests of domestic and partner country

(ROW) lobby groups into account during negotiations, then organized

industries are likely to receive smaller (larger) tariff reductions during

WTO negotiations.

In light of this, I used tariff, Non-Tariff Barriers (NTBs) and

protection coverage share as a measure of protection. Ad-valorem

tariff rates were obtained as the ratio of aggregated duty collected bycustoms over the value of imports.12 NTBs for Canadian imports were

obtained from the TRAINS database maintained by UNCTAD, which

shows the proportion of imports that is covered by one or more

qualitative restrictions. These data were available at the HS-6 level and

were aggregated into NAICS-6 groups. In addition, the protection share

variable was constructed as the share of Canadian imports that is

subject either to the positive import tariff or NTBs.

Descriptive statistics for protection measures and market shares

are presented in Table 1. In 1997 the average tariff rate, NTBs and

protection coverage ratios for the ROW imports were 4.8%, 18.2% and

77.5%, respectively. Tariffs and NTBs are highly correlated both within

and outside of the FTA, which implies that different measures of

protection are still highly complementary.

4.2. Political organization dummies

Many previous studies that have tested the GH model empirically

used rm-level political contributions to assign the value for the

political organization dummy variable.13 Although these data are

10 This result follows from the Cobb-Douglas utility function. Fixed product

expenditure shares imply that the import tariff imposed on one variety will raise

consumer's expenditure on all varieties through aggregate price index proportionally

to their market shares because large market share is indicative of the number of

varieties produced in a given country, productivity advantage, and consumers

preferences toward varieties produced in that country. Therefore, the higher is the

ROW market share (and the lower is the share of other varieties), the less harmful is

the import tariff for the ROW exporters.

11 Mexico also have preferential market access in Canada in 1997 but since there is no

evidence on the presence of Mexican lobby in Canada in the data. Israel is another

country that had trade agreement with Canada at that time and there are Israeli rms

lobbying trade interest in Canada. But since this FTA came into force on January 1,1997,

it is hard to classify these rms according to market access using 1996-97 data.

Therefore, I treat US as a single Canadian FTA partner country.12 Therefore, tariff measure controls for some non-tariff distortions as well, such as

antidumping or countervailing duties.13 For example, Goldberg and Maggi (1999), Gawande and Bandyopadhyay (2000),

Facchini et al. (2006), Bombardini (2008).



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available for Canada for 1997 and afterwards, this paper uses a

different approach. As was previously mentioned, foreign corpora-

tions prefer direct lobbying to political contributions because

transparency of political contributions may raise concerns about

foreign interference into political processes. Furthermore, since

different means of political involvement are highly correlated (Hansen

and Mitchell, 2000), direct lobbying seems to be an appropriate

measure for domestic political activity as well.

In this work, the degree of political activity in an industry is

measured by the number of lobbyists representing the corporate

interests of that industry. The Lobbyists Registration Act (LRA) requires

every individual to registerat theLobby Registrar Canadaif the person

seeks a meeting or a phone call to any public of ce holder regarding

the development, modication or cancellation of legislative proposals,

regulations, public policies and programs. The assumption that

political contributions will be ineffective for the determination of

trade policy without such contact seems to be reasonable and,

therefore, political contributions should be followed up by a personal

contact with a policymaker. For this reason, the number of registered

lobbyists is used to measure rm-level lobbying intensity within an

industry.

The main advantage of this data set is the large amount of detailed

information lobbyists are required to submit. This includes informa-tion on the business address of a corporation that benets from

lobbying, its subsidiaries and headquarters, and the objective of the

meeting with a public of ce holder. This information is very helpful in

determining the “nationality” and industrial af liation of lobbyists

representing interests of multi-product multinational corporations.

Another advantage of this data set is that it gives a very narrow

denition of a lobbyist. Any person representing his or her own

interests, and who is not being paid for arranging the meeting with

the public of ce holder, is not obliged to register. This removes

information on the very small rms. Large rms, which have high

lobbying power and can effectively inuence the decisions of policy-

makers, typically use the service of professional consultants or

corporate lobbyists, who are required to register.

Firms were assigned a NAICS-6 industry code using the CanadianCompany Capability database maintained by Industry Canada. As a

result, each lobbyist is matched to at least one industry, and for

companies that report multi-industry activity the number of lobbyists

was replicated over all sectors of operation. Assigning an industry

code to some multi-product rms still involves some degree of

discretion. For example, some rms in the automobile sector operate

in more than ten NAICS-6 industries. Since the numberof such rms is

relatively small, I assigned each rms to no more than three main

NAICS codes using different information sources: the Canadian

Company Capability database, the Federal Corporations Registry and

the North America Compustat database. The databases listed above

allow assigning industry codes to US and ROW rms. The LRA also

requires lobbyists to declare a “subject-matter in respect to which an

individual undertakes to communicate with a public of ce holder.” In

many cases, information on the purpose of lobbying activity reported

in the lobbyist registration form allowed me to attribute a multi-

product rm to a single (or a small number of ) NAICS codes where

rm's lobbying activity is mostly focused on.

National af liation of each rm that a particular lobbyist is

representing was determined from location of its manufacturing

facilities14 and constructed from two sources. First, the lobbyist regis-

tration form requires registrants to provide “the name and business

address of the parent corporation and those subsidiaries which directly

benet from the lobbying.” Sometimes, lobbyists provide incompleteinformation and do not include information on domestic and/or foreign

subsidiaries. In this case thedata wascomplemented by the information

from other databases mentioned previously. Again, quite often the

“nationality”of thermwas determined bythe “objective” section of the

lobbyist registration form.15

There are two more advantages of using lobbyists' registry data

over using political contribution data. First, all lobbyists are required

to identify the broad subject matter of their lobbying activity and in

this paper I restrict the sample to only lobbyists concerned with trade

policy issues. It allows one to isolate effectively rms lobbying

particularly for a change in trade policy from those lobbying for other

broad policy issues such as tax policy, environment, etc. This is

especially a problem for domestic lobbyists: on average, only one out

of eight lobbyists, representing the domestic manufacturing sector, isconcerned with trade policy. Therefore, pooling political contributions

by all domesticrmsmay cause serious measurement problems in the

political organization variable for trade policy analysis.

Second, the main channel used by foreign rms to lobby their

interest in Canada is through local subsidiaries, which distribute the

14 For example, a US company that has manufacturing facilities in Canada is treated

as Canadian rm.15 For instance, a lobbyist of Toyota Canada Inc, Ontario-based subsidiary of Toyota

Motor Corp., was attributed to the ROWon the basis of the meeting purpose to “secure

international trade for automobile engines” as these engines are manufactured and

shipped from Japan. Moreover, this lobbying objective statement allows to pin down

the lobbyist to one specic NAICS6 industry.

Table 1

Descriptive statistics for protection measures and market shares, 1997

US ROW US ROW Canadian US ROW

US ROW NTB NTB Protection Protection Market Market Market

Tariff Tariff Coverage Coverage Share Share Share Share Share

Mean 0.013 0.048 0.172 0.182 0.563 0.775 0.661 0.223 0.116

Median 0.003 0.034 0 0 0.646 0.986 0.683 0.205 0.075

Standard Deviation 0.076 0.053 0.314 0.307 0.419 0.328 0.222 0.162 0.134

Minimum 0 0 0 0 0 0 0 0 0

Maximum 1.17 0.54 1 1 1 1 1 0.70 0.64Corr. with tariff 1 1 0.46 0.68 0.14 0.45

Corr. with NTB 0.46 0.68 1 1 0.45 0.35

Corr. with protection share 0.14 0.45 0.45 0.35 1 1

No. of observations 248 248 248 248 248 248 248 248 248

Table 2

Descriptive statistics for the number of lobbyists, 1996–97

Canada US ROW

Average number of lobbyists per sector 1.94 1.08 1.15

Median number of lobbyists 1 0 0

Standard Deviation 3.30 2.06 2.32

Minimum 0 0 0

Maximum 18 12 14

Total number of lobbyists 481 267 284

% of sectors with at least one lobbyist 0.50 0.32 0.35

% of sectors with at least two lobbyists 0.38 0.26 0.26

% of sectors with at least three lobbyists 0.23 0.19 0.15



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imported goods within Canada. Formally, these rms should be

assigned to the service sector (NAICS 41–45) and dropped from the

sample, but this would substantially underestimate lobbying efforts

by foreign rms. For each service rm concerned with international

trade policy issues I used the company prole and lobbying objectives

information to assign an appropriate manufacturing industry code

and country if the rm has a manufacturing headquarter. Therefore,

lobbying data allows to control more effectively for foreign lobbying

activity in Canada.The amendment to the LRA announced in 1995 introduced several

important renements that made it more desirable to use post-1995

lobbying data. First, for the purpose of transparency, the lobbyists'

registry database became available for research purposes. Second, this

amendment extended the amount of information that must be

reported. But most importantly, it made disclosed information more

complete and reliable. For the rst time lobbyists were obliged to

provide all the information, and effective enforcement devices were

introduced to encourage better compliance. It extended the power of

the Lobbyists Registrar, which was authorized to seek clarication of

information submitted. The registrar was allowed to conduct an audit

of provided information and, when necessary, investigate the

provided information and impose sanctions for violating the LRA.16

For these reasons, the data for political activity by rms were

collected for the 1997 election cycle and complemented with the 1996

lobbying data to take into account a possible small lag in trade policy

responseto lobbying efforts. Therefore, foreach industry I calculated the

total number of Canadian, US and ROW lobbyists and, similarly to other

studies, several thresholds for the number of lobbyists in an industry

were set to determine the values of political organization dummies.

Descriptive statistics for the number of lobbyists is provided in Table 2.

4.3. The elasticities of substitution

To my knowledge, there are no studies to date that estimate

substitution elasticities for Canadian NAICS-6 industries, especially

within a framework of monopolistic competition. In this study,

substitution elasticities were estimated using the approach by

Feenstra (1994), recently applied by Broda and Weinstein (2006) toa large set of US imported commodities.

Table 3 presents the summary statistics.17 As a robustness check, I

estimated the substitution elasticities for NAICS industries at various

level of aggregation and veried that more aggregated commodities

are more differentiated: the average value of σ decreased from 5.85 to

5.34 and 4.56 while moving respectively from six to ve and four

digits NAICS. As another robustness check, I estimated US elasticity of

substitution using the same estimation procedure, time period, and

industry classication. Presumably, consumers in Canada and the US

should have similar tastes, and varieties that are close substitutes in

Canada should be close substitutes in the US as well. This suggestion is

supported by 0.69 correlation coef cient.

4.4. Instrumental variables

In Eq. (10), market shares are likely to be determined simulta-

neously with the tariff rates and should be properly instrumented.

Treer (1993) proposed to instrument the import penetration ratio

with industry factor endowments as the measure of comparative

advantage independent of the level of protection. Following this

approach, a list of instruments for the Canadian market share

includes: the share of production to non- production workers, the

capital stock in machinery and construction, inventories, and the

consumption of fuel and electricity. All of these data are provided by

Statistics Canada. Thesame list of instruments was constructed for the

US market share in Canada using the US Census data.

To instrument the ROW share in the Canadian market, the

“gravity”-type distance measure between Canada and the average

exporter was constructed. For every product, the pair-wise log-

distance between Canada and the exporting country was weighted by

theshare of this country in theglobal export of theproduct.18The total

exports by country and by sector were constructed using the UNCTADdatabase. The data on geographic distance, weighted by population

density and economic activity within each country, were taken from

the Centre d'Etudes Prospectives et d'Informations Internationales.

Therationale for using this “distance” variableis thefollowing:if main

producers of a particular good are located far from Canada,

transportation costs are high and the ROW share in the Canadian

market is likely to be small regardless of Canadian trade policy.

Politicalorganizationdummiesare likely to be measuredwith error

and are potentially endogenous. To instrument the US and Canadian

political organization dummies, I use the information industrial

concentration, such as shares of big and medium rms and the CR-4

concentration ratio. Industrial concentration is mostly technologically

determined and at the same time it is easier for rms in more

concentrated industries to overcome free-riding problem and form a

lobby group. The ROW lobbying intensity is instrumented with the

country-level CR-4 concentration ratio on Canadian imports market.

The right-hand side variables of Eq. (11) include non-linear

combinations of endogenous variables and to consistently estimate

its coef cients I use LIML estimator proposed by Kelejian (1971) with

Bekker (1994) standard error correction.19 Hansen et al. (2006)

demonstrated that this approach has better small sample properties

than 2SLS and is asymptotically correct in the presence of many

instruments and many weak instruments.

5. Results

5.1. Test of a benchmark GH model

As a starting point, I will present the results on a GH version of themodel with homogeneous goods to test how well the new data on

Canada can t the benchmark model and compare its performance

with the results of previous empirical studies. Since in the benchmark

model markets are perfectly competitive and import supply is

innitely elastic, there is no reason for foreign rms to participate in

lobbying, and in the benchmark case I will consider only the effect of

domestic lobbying groups on the home country trade policy.16 In 2001 an independent study of compliance to the LRA was conducted by KPMGConsulting Inc. (2001). The already-registered lobbyists were asked if they were aware

of any non-compliance behavior. Reported results indicate that 50% of consultant

lobbyists and 15% of corporate lobbyists were aware of non-registered lobbying, while

they evaluated the aggregate compliance rate at 70% and 100%, respectively. In general,

compliance was perceived to be high, although non-compliance behavior is still an

important issue.17 Price elasticities of the ROW import demand were calculated from consumers

demand function: e i =

AqROWi

A pROWi

pROWi

qROWi = σ i− σ i−1ð ÞsROW i

.

Table 3

Descriptive statistics for the elasticity of substitution and price elasticity

Elasticity of substitution Elasticity of import demand

Mean 5.83 5.32

Standard Deviation 3.06 2.97

Median 4.98 4.52

Minimum 1.43 0.17

Maximum 21.47 21.36

No. of observations 248 248

18 Since the exporter's share on the Canadian market is endogenous, I use the share

on the global market excluding Canada, which is unaffected by Canadian tariff rate.19 To account for non-linearity of the endogenous variables, the list of instruments

also includes quadratic terms and cross products of exogenous variables, selected on

the basis of their correlation with endogenous variables.



8/13


9/13

substitutes and markets are imperfectly competitive. The positive

level of protection for unorganized sectors is in contrast to the

benchmark GH model and nds strong support in the data. As the

theory predicts, among politically unorganized sectors protection

increases with the share of domestic rms on the market. When

protection is measured with tariffs, the point estimate for β 1 in the

most preferred specication in terms of the log-likelihood function

(column (3)) is 0.21, which converts to the welfare-maximizing ad-

valorem import tariff of 2.2% for an average Canadian industry, given

the average Canadian market share, price and substitution elasticitiesof 0.66, 5.32 and 5.83, respectively. In terms of the optimal level of

NTBs and protection share, the welfare-maximizing NTB coverage for

the average industry is estimated to be 8.9% of total imports from

outside of the FTA, while the welfare-maximizing share of imports

subject to any trade restriction is 17.9%.

The effect of a politically organized domestic lobbying (coef cient

β 2) is always estimated to be positive and very signicant, indepen-

dentlyof theconstruction of thepolitical organizationdummy andthe

measure of trade distortion. Everything else being equal, active

domestic lobbying in the industry leads to a higher level of protection

andthis effectis signicant androbust acrossall specications. Table 6

shows the change in the tariff rate and NTB had the average domestic

or foreign industry changed its status from unorganized to organized.

The results imply that the presence of a politically organized domestic

lobby tends to increase import tariffs by 5.4% for the average industry,

the NTB coverage ratio by 29.7%, and the protection share by 31.7%.

The novel results of this section are the estimates of coef cients β 3and β 4. The coef cient β 3 measures the effect of the FTA partner

country's lobbying and is always estimated to be positive, although

with tariffs as a measure of protection it is insignicant in two

specications. As expected, the effect of US lobbying is much stronger

on NTBs than on tariffs. This is consistent with the initial hypothesisthat in the presence of tariff regulation by the WTO, domestic and

partner country lobbyists can affect tariffs only by resisting to

multilateral trade liberalization during post-NAFTA WTO rounds of

trade negotiations. In the short run, the effect of US lobbying on

Canadian import tariff may be not as pronounced as the effect on

NTBs, adopted unilaterally by Canadian government.

The effect of the ROW lobbying (coef cient β 4) is always negative

and signicant at 5% except for two specications with NTBs,

presumably because foreign lobbies are more effective in lobbying

Table 5

Estimation results for the monopolistically competitive model (10) with foreign lobbying and different protection measures

Dependent variable

Tariffs NTBs Protection share

(1) (2) (3) (1) (2) (3) (1) (2) (3)

S iH 0.072 0.179⁎⁎ 0.210⁎⁎ 0.828 0.939⁎ 0.868⁎ 0.915 1.757⁎⁎ 1.741⁎⁎

(0.093) (0.085) (0.084) (0.636) (0.570) (0.524) (0.848) (0.802) (0.792)

I iH S i

H 0.472⁎⁎⁎ 0.557⁎⁎⁎ 0.528⁎⁎⁎ 2.320⁎⁎⁎ 3.512⁎⁎⁎ 2.895⁎⁎⁎ 2.966⁎⁎⁎ 3.091⁎⁎⁎ 3.086⁎⁎⁎

(0.059) (0.070) (0.069) (0.403) (0.468) (0.429) (0.537) (0.655) (0.648)

I iP S iP 0.150 0.156 0.345⁎ 3.047⁎⁎⁎ 2.152⁎ 3.033⁎⁎⁎ 4.064⁎⁎⁎ 5.041⁎⁎⁎ 5.515⁎⁎⁎

(0.158) (0.167) (0.174) (1.079) (1.119) (1.082) (1.438) (1.568) (1.634)

I iROW (S i

ROW−1) −0.109⁎⁎ −0.264⁎⁎⁎ −0.246⁎⁎⁎ 0.005 −0.914⁎⁎ −0.715 −1.910⁎⁎⁎ −2.542⁎⁎⁎ −2.491⁎⁎⁎

(0.051) (0.067) (0.073) (0.345) (0.447) (0.453) (0.460) (0.626) (0.684)

Structural parameters

α 1.97 1.47 1.50 0.07 0.02 0.05 0.03 −0.25 −0.24

(0.270) (0.228) (0.244) (0.313) (0.188) (0.208) (0.330) (0.317) (0.310)

a 0.15 0.32 0.40 0.36 0.27 0.30 0.31 0.57 0.56

(0.238) (0.191) (0.201) (0.351) (0.200) (0.222) (0.360) (0.350) (0.340)

b 0.32 0.28 0.65 1.31 0.61 1.05 1.37 1.63 1.79

(0.356) (0.314) (0.355) (0.591) (0.352) (0.428) (0.623) (0.691) (0.698)

c 0.23 0.47 0.47 0.00 0.26 0.25 0.64 0.82 0.81

(0.112) (0.131) (0.156) (0.153) (0.131) (0.164) (0.193) (0.261) (0.290)

N 248 248 248 248 248 248 248 248 248

Log-likelihood −74.2 −70.1 −68.9 −550.7 −542.1 −522.1 −622.0 −625.7 −624.3

AIC 0.64 0.61 0.60 4.48 4.41 4.25 5.06 5.09 5.08

Notes: ⁎, ⁎⁎ and ⁎⁎⁎ denote statistical signicance at 10%, 5% and 1%, respectively. Standard errors in parenthesis. In columns (1) and (2) an industry is politically organized if it is

representedby 1 and 3 lobbyists, respectively. In column (3) an industry is politicallyorganized if it is represented byat least 3 lobbyists and accounts for strictly morethan one third

of the total number of lobbyists in that industry.

Table 7

The effect of domestic and foreign lobbying on Canadian average levels of protection

Protection measure (industry average, %)

Tariffs (4.81) NTB (18.19) Protection s hare ( 77.53)

(1) (2) (3) (1) (2) (3) (1) (2) (3)

Average

effect of

domestic

lobbying

2.65 1.41 1.33 13.04 8.88 7.31 16.67 7.81 7.8

Average

effect of

partner

country

lobbying

0.22 0.13 0.21 4.53 1.82 1.87 6.04 4.26 3.4

Average

effect

of ROW

lobbying

−0.06 −0.65 −0.48 0 −2.24 −1.38 −10.51 −6.24 −4.81

Table 6

The effect of an active lobbying group presence on the level of protection in an average

industry

Protection measure (industry average, %)

Tariff s ( 4.81) NTB ( 18.19) Pr ot ect ion share ( 77.53)

(1) (2) (3) (1) (2) (3) (1) (2) (3)

Active

domestic

lobbying

4.85 5.72 5.42 23.83 36.07 29.73 30.46 31.74 33.49

Active

partner

country

lobbying

0.52 0.54 1.19 10.54 7.4 4 10.49 14.0 6 17.4 4 25.65

Active ROW

lobbying

−1.5 −3.62 −3.38 −0.68 −12.55 −9.81 −26.22 −34.9 −42.77



10/13

for tariff using WTO mechanisms. According to these results, the

presence of politically organized US industries in Canada leads to

higher Canadian import barriers and the ROW lobbying effort is

negatively correlated with the Canadian protection measures. Thus, it

seems safe to conclude that, while ourresults do not allow researchers

to get a precise estimate of β 3, they strongly support the hypothesis of

foreign lobby differentiation with respect to market access implied by

the FTA and predicted by the theoretical model of Section 3. The point

estimates of coef cient β 3 in specications with the best data t are

0.345 (column (3) for tariffs), 3.033 (column (3) for NTBs) and 5.041

(columns (2) for protection share). Table 6 shows the implication of

these estimates for the observed levels of protection. A politically

organized industry in the FTA partner country tends to increase a

country's average import tariff for that industry by 1.2%, average NTBcoverage by 10.5% and average protection coverage by 17.4%. Similarly,

the presenceof a politically organized group of exporters from outside

of the FTA tends to decrease the average Canadian import tariff by

3.4%, the average NTB by 9.8% and the average protection share by

34.9% . These numbers are economically plausible and provide

additional support to the estimates of the model.

Estimates of Eq. (11) allow one to derive the values of the structural

parameters of the model. As expected, absolute magnitudes of

coef cient β 4 are always less than β 2. Since the strength of domestic

lobbying is normalized to one, c b1 implies that ROW lobbying is

relatively less important for Canadian policymakers than lobbying by

domestic rms. With thevalues of c between 0.25 and 0.5, foreign rms

need to spend 2–4 time more on lobbying than domestic rms to have

thesameeffect on policyoutcomes. This resultis notsurprising given thelegislative restrictions on contributions by foreign rms in Canada. In

spite of that, policymakers' valuation of contributions from abroadis still

positive and signicantly different from zero. The estimates of the

government's preferences towards political contributions from the FTA

partner country (parameter b) depend on the protection measure that

US rms are trying to affect. In lobbying for tariffs, partner country

contributions are estimated to be 35–80% less effective than domestic

contributions, while in lobbying for NTBs the effectiveness of domestic

and partner country lobbying is approximately equal. Finally, when

trade distortions are measured by protection share, the government's

valuation of political contributions fromthe FTApartner country relative

to domestic ones rises to 1.63. However, in neither case the hypothesis

that b=1 can berejectedat 95% condence level, suggestingeither lower

levels of political risk associated with protecting interests of US rms in

Canada, or high interest and ownership interconnections amongst

Canadian and US rms.

At the same time, US contributions seem to be more important

than contributions from the ROW. Depending on the specication, the

government's valuation of US contributions is estimated to be two

times the valuation of contributions from other countries. Among

possible reasons are greater proximity of the US and Canadian

nancial systems and a more sophisticated mixture of asset structure

that makes it more dif cult to distinguish between Canadian and US

rms (relative to the distinction between Canadian and ROW rms).

The estimates of the population share organized into lobbying vary

substantially across different specications. In tariff equations, the

parameter o is always greater than one, but the standard error is very

large and 95% condence intervals almost always overlap with the[0;1] interval. In equations with NTBs and protection shares, point

estimates for o are also very imprecise and in all specications one

cannot rule out the possibility that α is negative.21

As for the relative importance of national welfare for the government,

the parameter a is estimated to be 0.3–0.5 with reasonable degree of

precision as compared to the benchmark GH model. It implies that when

organized interests lobby for a change in tariff policy, the government's

valuation of political contributions is three to ve times higher than the

valuation of national welfare net of contribution. The result that

policymakers are driven mostly by political contributions they receive

from different lobby groups sharply contrasts with results obtained

previously in a perfectlycompetitive setup:Gawande and Bandyopadhyay

(2000) estimated a to be over 3, 000; in Goldberg and Maggi (1999) its

value is around 70. My own estimates for Canada fall in the range 30–100(see Section 5.1). However, Gawande and Bandyopadhyay (2000)

recognized that high estimates of a contradict the empirical evidence

that welfare loss from protection is always greater than the amount of

political contributions policymakers receive in exchange for protection,

and onlywithlow valuesof a we would observe enoughvariation in tariffs

relative to welfare-maximizing rates.

Estimates of the reduced from Eq. (11) shown in Table 5 have a

meaningful economic interpretation for an averageCanadian industry.

Given the average market shares of the three groups of rms, price

Table 8

Estimation results for the monopolistically competitive model (10) with additional controls

Dependent variable

Tariffs NTB Protection share

(1) (2) (3) (1) (2) (3) (1) (2) (3)

S iH 0.210⁎⁎ 0.307⁎⁎⁎ 0.210⁎⁎⁎ 1.503⁎⁎⁎ 1.555⁎⁎⁎ 1.247⁎ 1.999⁎⁎⁎ 2.727⁎⁎⁎ 1.941⁎⁎⁎

(0.099) (0.089) (0.091) (0.686) (0.610) (0.658) (0.909) (0.857) (0.856)

I iH S i

H 0.412⁎⁎⁎ 0.506⁎⁎⁎ 0.393⁎⁎⁎ 2.024⁎⁎⁎ 3.302⁎⁎⁎ 2.165⁎⁎⁎ 2.506⁎⁎⁎ 2.630⁎⁎⁎ 2.498⁎⁎⁎

(0.058) (0.067) (0.056) (0.406) (0.460) (0.405) (0.538) (0.646) (0.527)

I iP S iP 0.194 0.224 0.307⁎⁎ 3.254⁎⁎⁎ 2.636⁎⁎⁎ 3.432⁎⁎⁎ 4.401⁎⁎⁎ 5.165⁎⁎⁎ 5.727⁎⁎⁎

(0.159) (0.163) (0.156) (1.104) (1.116) (1.127) (1.463) (1.568) (1.467)

I iROW (S i

ROW−1) −0.100⁎⁎⁎ −0.260⁎⁎⁎ −0.202⁎⁎⁎ 0.044 −0.878⁎⁎ −0.458 −1.849⁎⁎⁎ −2.563⁎⁎⁎ −1.989⁎⁎⁎

(0.051) (0.065) (0.055) (0.355) (0.449) (0.397) (0.470) (0.631) (0.517)

CR4 0.029⁎⁎⁎ 0.038⁎⁎⁎ 0.032⁎⁎⁎ 0.017⁎⁎⁎ 0.022⁎⁎⁎ 0.021⁎⁎⁎ 0.014⁎ 0.020⁎⁎ 0.009⁎

(0.011) (0.011) (0.010) (0.007) (0.007) (0.007) (0.008) (0.010) (0.005)

K /L −0.075⁎ −0.067 −0.075⁎ 0.013 0.198 −0.051 −0.018⁎⁎⁎ −0.017⁎⁎⁎ −0.018⁎⁎⁎

(0.045) (0.043) (0.042) (0.310) (0.296) (0.306) (0.004) (0.004) (0.004)

Wage −0.094⁎⁎⁎ −0.106⁎⁎⁎ −0.087⁎⁎⁎ −0.060⁎⁎⁎ −0.068⁎⁎⁎ −0.054⁎⁎⁎ −0.263⁎⁎⁎ −0.397⁎⁎⁎ −0.202⁎⁎⁎

(0.0061) (0.0059) (0.0058) (0.0042) (0.0040) (0.0042) (0.056) (0.057) (0.054)

N 248 248 248 248 248 248 248 248 248

Log-likelihood −61.4 −53.0 −48.9 −542.3 −530.3 −538.7 −612.1 −614.7 −603.9

AIC 0.56 0.49 0.46 4.44 4.34 4.41 5.00 5.02 4.93


represented by 1 and 3 lobbyists,respectively. In column (3) an industry is politically organized if it is represented byat least 3 lobbyistsand accounts for strictly morethan one third

of a total number of lobbyists in that industry.

21 High volatility in the estimates of a across different measures of trade protection

can be a scale effect as α appears in denominator of all reduced form coef cients. It

also should be pointed out that measuring α is a standard problem in the literature

and its estimation proved to be dif cult.



11/13

and substitution elasticities, one can back up the welfare maximizinglevel of protection and the average effect of each lobby group on

Canadian trade policy. Table 7 shows the fraction of Canada's average

tariff and NTB that is explained by domestic and foreign lobbying.22 As

a result, the average Canadian industry receives 1.33% import tariffs,

7.31% NTB coverage and 7.81% protection share from lobbying by

domestic rms; 0.21% tariffs, 1.87% NTBs and 4.26% protection share

from lobbying by partner country rms − 0.48% tariffs, − 1.38% NTBs

and −6.24% protection share from lobbying by ROW rms. These

results are economically reasonable and statistically signicant.

5.3. Robustness tests

Up to now, we tested structural relationshipbetweentrade policy

outcomes and lobbying activity by domestic and foreign interest

groups. However, the main message of the previous section still

holds in a more general setup. Table 8 presents extended regressions

that include other explanatory variables of trade policy predicted by

earlier literature. We expect that more concentrated industries are

more easily get organized and are more effective in lobbying for

protections labor-intensive industries receive more protection from

the government because in a capital-abundant country these are

more likely to be import-competing industries; and industries with

greater numbers of unskilled low-paid workers are more protected

by the government for social justice reasons. Table 8 indicates that

all additional variables have expected signs and mostly signicant.

Table 9

Estimation results for the monopolistically competitive model (10) with additional controls and without elasticity adjustment of the dependent variable

Dependent variable


(1) (2) (3) (1) (2) (3) (1) (2) (3)

S iH −0.009 0.006 −0.008 0.065 0.070 0.031 −0.355⁎⁎⁎ −0.239⁎⁎⁎ −0.357⁎⁎⁎

(0.014) (0.012) (0.013) (0.084) (0.075) (0.081) (0.081) (0.079) (0.076)

I iH S i

H 0.057⁎⁎⁎ 0.067⁎⁎⁎ 0.051⁎⁎⁎ 0.261⁎⁎⁎ 0.408⁎⁎⁎ 0.267⁎⁎⁎ 0.301⁎⁎⁎ 0.233⁎⁎⁎ 0.277⁎⁎⁎

(0.008) (0.009) (0.008) (0.050) (0.057) (0.050) (0.048) (0.060) (0.047)

I iP S iP 0.002 0.003 0.006 0.336⁎⁎⁎ 0.243⁎ 0.327⁎⁎⁎ 0.231⁎ 0.280⁎ 0.275⁎⁎

(0.022) (0.023) (0.022) (0.136) (0.137) (0.139) (0.131) (0.145) (0.130)

I iROW (S i

ROW−1) −0.012⁎ −0.039⁎⁎⁎ −0.033⁎⁎⁎ 0.036 −0.138⁎⁎⁎ −0.075 −0.208⁎⁎⁎ −0.292⁎⁎⁎ −0.252⁎⁎⁎

(0.007) (0.009) (0.008) (0.044) (0.055) (0.049) (0.042) (0.058) (0.046)

CR4 0.031⁎⁎ 0.044⁎⁎⁎ 0.037⁎⁎⁎ 0.019⁎⁎⁎ 0.028⁎⁎⁎ 0.026⁎⁎⁎ −0.052 0.037 −0.079

(0.015) (0.015) (0.014) (0.009) (0.009) (0.009) (0.089) (0.093) (0.086)

K /L −0.003 −0.007 0.000 0.002 0.004 0.001 −0.024⁎⁎⁎ −0.025⁎⁎⁎ −0.023⁎⁎⁎

(0.006) (0.0609) (0.059) (0.004) (0.004) (0.004) (0.004) (0.004) (0.004)

Wage −0.225⁎⁎⁎ −0.237⁎⁎⁎ −0.216⁎⁎⁎ −0.107⁎⁎⁎ −0.114⁎⁎⁎ −0.098⁎⁎⁎ −0.324⁎⁎⁎ −0.428⁎⁎⁎ −0.272⁎⁎⁎

(0.085) (0.082) (0.080) (0.005) (0.005) (0.005) (0.050) (0.052) (0.048)

N 248 248 248 248 248 248 248 248 248

Log-likelihood 428.7 436.8 441.7 −22.2 −10.4 −19.0 −13.3 −24.0 −2.5

AIC −3.39 −3.46 −3.50 0.24 0.15 0.22 0.17 0.26 0.08




Table 10

Estimation results for the monopolistically competitive model (10) when multinationals with manufacturing facilities in Canada being treated as foreign rms

Dependent variable


(1) (2) (3) (1) (2) (3) (1) (2) (3)

S iH 0.079 0.198⁎⁎ 0.267⁎⁎⁎ 0.912 1.079⁎ 1.202⁎⁎ 1.183 1.899⁎⁎ 2.037⁎⁎

(0.093) (0.085) (0.088) (0.641) (0.564) (0.555) (0.858) (0.791) (0.792)

I iH S i

H 0.481⁎⁎⁎ 0.598⁎⁎⁎ 0.467⁎⁎⁎ 2.352⁎⁎⁎ 3.618⁎⁎⁎ 3.965⁎⁎⁎ 2.901⁎⁎⁎ 3.427⁎⁎⁎ 3.178⁎⁎⁎

(0.059) (0.072) (0.078) (0.403) (0.475) (0.491) (0.540) (0.666) (0.701)

I iP S i

P 0.112 0.219 0.393⁎⁎ 2.619⁎⁎ 3.143⁎⁎⁎ 3.468⁎⁎⁎ 3.903⁎⁎⁎ 5.807⁎⁎⁎ 5.865⁎⁎⁎

(0.150) (0.165) (0.176) (1.030) (1.096) (1.101) (1.377) (1.537) (1.573)

I iROW(S i

ROW−1) −0.093⁎ −0.200⁎⁎⁎ −0.169⁎⁎ −0.080 −1.043⁎⁎ −0.614 −1.822⁎⁎⁎ −2.452⁎⁎⁎ −2.363⁎⁎⁎

(0.050) (0.063) (0.073) (0.343) (0.421) (0.460) (0.459) (0.590) (0.657)

Structural parametersα 1.91 1.34 1.57 0.04 −0.02 −0.05 −0.06 −0.26 −0.33

(0.264) (0.205) (0.317) (0.315) (0.181) (0.162) (0.349) (0.283) (0.307)

a 0.16 0.33 0.57 0.39 0.30 0.30 0.41 0.55 0.64

(0.234) (0.178) (0.252) (0.350) (0.193) (0.171) (0.381) (0.310) (0.340)

b 0.23 0.37 0.84 1.11 0.87 0.87 1.34 1.69 1.85

(0.326) (0.291) (0.412) (0.530) (0.348) (0.306) (0.600) (0.615) (0.664)

c 0.19 0.33 0.36 0.03 0.29 0.15 0.63 0.72 0.74

(0.108) (0.110) (0.176) (0.149) (0.119) (0.120) (0.200) (0.211) (0.279)

N 248 248 248 248 248 248 248 248 248

Log-Likelihood −74.0 −70.1 −82.0 −552.3 −539.5 −537.4 −624.5 −623.4 −625.8

AIC 0.64 0.61 0.70 4.49 4.39 4.37 5.08 5.07 5.09




22 i.e. by calculating a simple average of the tted values of the dependent variable

implied by the model estimates. Therefore, by construction, the contribution of each

lobby group to the average import tariff and NTB goes down to zero as the threshold for

the number of lobbyists in the denition of political organization dummies goes up.



12/13

But more importantly, all coef cients of the central concerns, β 2, β 3and β 4, preserve their signs and signicance. Table 9 reports results

for specication (11) with additional control variables and without

adjustment of the dependent variable by elasticity terms. Again, US

lobbying activity in Canada is always found to lead to more

protection, while ROW lobbying is associated with lower levels of

protection.

To examine the robustness of the results with respect to the

denition of a foreign lobbyist, Eq. (10) was estimated using the data

in which nationality of a lobbyist was determined on the basis of the

location of its client's headquarter rather than manufacturing

facilities. Since many US multinationals lobbying in Canada operatelocal af liates, this data transformation affects primarily the number

of US lobbyists raising it to 1.31 per industry. The results are reported

in Table 10. Once again, they indicate positive and signicant effect of

the US lobbying on the level of trade protection in Canada, which is

not surprising given common lobbying interests of Canadian and US

multinationalrms. On the other hand, theeffect of the ROW lobbying

for tariffs gets weaker,whichmay reect conicting interest of foreign

importers and multinationals serving Canadian market through their

local subsidiaries.

5.4. The comparison of the benchmark with monopolistic competition GH

models

This paper is the rst one that estimates empirically the GH modelwith monopolistically competitive market structure. To test this

version of the model versus the benchmark model with perfect com-

petition, I used a J -test for non-nested hypothesis testing (Davidson

and MacKinnon, 1993, p. 388). The testing procedure requires the

same dependent variable, so for the purpose of this section both

sides of Eq. (11) were multiplied by σ iσ i−1

, and 1σ i

was moved to the right-

hand side. The alternative benchmark specication (13) remains

unchanged.

As in Davidson and MacKinnon (1993), let f (si j, I i

j, σ i) be a LIML

regression model for the monopolistic competition specication (11),

and let g (sih, I i

h) be a LIML regression model for the benchmark

specication (13). The validity of the benchmark GH model can be

tested using an augmented LIML regression g = g (sih, I i

h) +λ1 f where f

is constructed fromtted values of theLIML estimation of Eq. (11). The

benchmark GH model is rejected in favor of the monopolistic

competition model if the test for λ1=0 is rejected. In a similar way, the

monopolistic competition model is rejected in favor of the benchmark

GH if in the regression model f = f (si, I i j, σ i) +λ 2 ĝ the hypothesis λ2=0 is

rejected.

The J -test results for three measures of protection are presented in

Table 11. For each measure of protection the rst two rows of each

panel of Table 11 compare the benchmark versus the full monopolistic

competition model with three lobby groups. However, the original GHmodel does not allow to analyze the behavior of foreign lobbies and

the last two rows of each panel compare GH versus monopolistic

competition model without foreign lobbying to isolate the effect of

imperfectly competitive market structure on explanatory power of

“protection for sale” model. The results of Table 11 suggest that

neither model can be rejected as a correct one when protection is

measured with tariffs. At the same time, the benchmark GH model is

always weakly rejected in favor of the model with monopolistic

competition as the monopolistically competitive specication of the

model adds more explanatory power. The second part of each section

of the table displays J -test results for the benchmark model and

monopolistic competition with only domestic lobbying, using the

same set of instruments. Again, neither model can be rejected, but

these results suggest that simply taking into account the imperfectly

competitive structure of the market improves the explanatory power

of the “Protection for sale” model.

When protection is measured with NTBs, J -test results indicate

that the benchmark model is rejected in favor of the monopolistic

competition model with foreign lobbies and weakly rejected in favor

of the model without foreign lobbies, while the monopolistic

competition version is never rejected. This implies that the mono-

polistically competitive model developed in this paper captures more

information than the model with perfect competition and better

explains cross-industry patterns of protection.

6. Conclusion

The main objective of this paper is to study the effect of political

economy factors on trade policy of an FTA in the presence of foreignlobbying. This paper accomplishes this goal by modifying the original

GH model through the introduction of a monopolistically competitive

market structure to allow for the presence of two types of foreign

lobbies: lobbies from the FTA partner country and from outside of the

agreement. The paper shows that signing a free trade agreement with

a politically active partner country leads to a welfare-reducing

increase in import tariffs in the presence of foreign lobbying.

The empirical results suggest that foreign lobbying has a

signicant and differentiated effect on Canadian trade policy as a

result of Canada's membership in NAFTA. This is the rst paper that

analyzes differentiation of foreign lobbying objectives, that follows

from the presence of the FTA, and I show empirically that this

differentiation does matter for Canadian trade policy. I quantify

domestic and foreign post-NAFTA lobbying activity in Canada andshow that US rms successfully lobby the Canadian government for

increases in trade barriers, while foreignrms from outside of NAFTA

effectively lobby in Canada for trade barrier reductions. This implies

that active lobbying by an FTA partner country is an additional

political economy factor that was not considered in previous

research and that may lead to more protectionist trade policies of

regional trading blocks and impede multilateral trade liberalization.

Moreover, in the environment where almost every country in the

world is a member of at least one regional trade agreement, for a

complete understanding of a country's trade policy we should not

onlyconsider the effect of foreign lobbying but also take into account

its differentiated effect. The empirical results also reveal that the GH

model with monopolistic competition has more explanatory power

than its original version.

Table 11

J −test for the benchmark and monopolistically competitive GH models

P -value

H0 H1 1 2 3

Dependent variable: tariffs

MC GH with foreign lobby is true Benchmark GH is true 0.50 0.55 0.59

Benchmark GH is true MC GH with foreign lobby is true 0.25 0.26 0.11

MC GH w/o foreign lobby is true Benchmark GH is true 0.42 0.45 0.43

Benchmark GH is true MC GH w/o foreign lobby is true 0.37 0.34 0.19

Dependent variable: NTBs





Dependent variable: Protection share





Notes: P -values denote the condence level for rejecting H0. MC stays for “Monopolistic

competition” version of GH model. In columns (1) and (2) an industry is politically

organized if it is represented by 1 and 3 lobbyists, respectively. In column (3) an

industry is politically organized if it is represented by at least 3 lobbyists and accounts

for strictly more than one third of the total number of lobbyists in that industry.



13/13

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