Essays in trade and political economy

This dissertation contains three essays on two cases of the interaction among government policy, citizen preferences, and economic environment that jointly affect economic outcomes. The first is a theoretical model explaining the economic rationale of GATT/WTO given non-homothetic preferences. The second is an empirical investigation of the effects of decentralized service provision and local government spending on re-election prospects of municipal mayors in the Philippines. The first essay sets up a new trade model and investigates the effects of non- homothetic preferences on production location. In a typical new trade theory model, tariff setting interacts with monopolistically competitive firms to determine the location of production. The vertical differentiation model used here, which is a model similar to Fajgelbaum et al. (2011), features two differentiated goods where an increase in income due to trade policy leads to greater demand for the high quality good and an expansion in the number of its varieties, a feature first introduced in Baldwin (1999). I find that the addition of non-homothetic preferences increases the market access effect present in these models for goods with a positive income effect. The second essay deals with the economic rationale of trade negotiations in the context of GATT/WTO, beginning with the seminal work by Bagwell and Staiger (1999). This chapter investigates the effects of non-homothetic preferences introduced in the first essay on interest group welfare over trade liberalization. I show that protection is preferred for the high quality good due to income effects. Consumption preferences and inequality across countries lead to different preferences between income groups over trade policy, even if trade policy does not lower any group's income. GATT/WTO principles applied to each good separately are insufficient to ensure all parties gain from the trade agreement, or whether all tariffs will be successfully liberalized. The third essay discusses fiscal policy, by decentralized Philippine municipal governments, as a tool to aid in re-elections. Political cycles (or Political Business Cycles, PBC) occur when government policy is manipulated to improve chances of re-election. Previous work suggests that incumbents use fiscal policy this way in several developing countries. Understanding local executives' behavior has implications on governance reforms that seek to make government more responsive. This papers unique contribution to the literature is to control for candidate's political experience and electoral competition. Looking at Philippine municipality income and expenditure accounts, I find strong evidence that increases in local government spending boosts the incumbent mayors vote share after controlling for political experience. The marginal effect of spending on vote share is lower when the incumbent and opposition face more competition. Looking at the composition of spending, I find little evidence that spending on health and education is associated with electoral gains, while spending on salaries and maintenance is associated with higher vote shares for the incumbent. In a cross-section of municipalities, I include campaign spending by incumbent and opposition candidates as a direct measure of political competition. I find that the fiscal policy remains important, and that campaign spending's effects on election results are as predicted by theory.