Institute for Applied Microeconomics
and Experimental Theory

Constitutional Choice and Barriers to Entry
Implications of Constitutional Choice on International Trade?

by Frank P. Maier-Rigaud
Department of Economics, Indiana University, Bloomington, USA
Paper  presented at the Miniconference of the Workshop for Political Theory and Policy Analysis,
May 2nd and 4th 1998



It is not my intention to enter the debate on the economics of international trade nor to enter a public choice discussion of why barriers to trade exist. Rather, I intend to show that free trade as a constitutional choice may in certain cases conflict with other constitutional preferences so that free trade is not a priori in the best interest of the constituents.
A widely recognized claim is that free trade is desirable in terms of constituents’ preferences. Arguments of this kind are normally backed by demonstrations of the allocative achievements of free market competition and the ensuing increase in wealth. I intend to show that the benefits of free trade largely depend on the framework within which free trade, and therefore competition occurs. Since this framework is formed by the constitutional preferences of the constituents within a particular jurisdiction, the definition of what should be considered a trade barrier ideally remains in the hands of the constituents. This approach to trade barriers differs substantially from the standard economic argument despite its adherence to the concept of methodological individualism. According to this standard argument, every regulation or norm that inhibits the free flow of goods and services is regarded as a trade barrier hindering competition and lowering wealth to the detriment of the constituents. A more sophisticated version posits that those regulations and rules that reflect choices on a constitutional level which cannot be made individually should be excluded from the definition. An example of this is safety requirements for cars, which are intended to promote a certain level of safety. I will argue that the narrow as well as the more sophisticated definitions of a trade barrier are inappropriate because of their a prioristic character.

Ideally, only the constituents can decide whether to voice their preferences on a constitutional, collective or individual level. Thus, the current discussion on trade barriers uses an inappropriate language and frame of reference to address the issue of constitutional choice and trade in a self-governing society. It seems crucial to me to address this area of conflict instead of simply assuming a bipolar world in which the constituents would certainly prefer to live in a free-trade regime as opposed to a regime characterized by pervasive protectionism.

1. Introduction

Adam Smith (1776/1981) was one of the first to point out that the extent of the market is crucial to the degree of specialization and to economic wealth. David Ricardo (1819/1971) added the theory of comparative advantage to the body of economic knowledge 50 years after Smith. Both of these contributions represent the foundation for the widely recognized argument that free trade is beneficial to all parties involved.  This generally accepted view on free trade has been challenged only by few economists. One of these challengers, who is widely misinterpreted today, is Friedrich List. List's concept of the “infant industries” that need protection is being misused particularly by the strategic trade school (see Hart and Prakash 1997 for a survey). List, who was intellectually influenced by Alexander Hamilton's Report on Manufactures (1791/1985), wanted protection for companies that were located in what we now call newly developed countries. He did not want sector specific protection for “promising industries” or high technology branches. He explicitly wanted to limit competition to areas where competition would be mutually beneficial.

Despite challenges such as those posed by List, it is generally recognized that free trade, at least among industrialized countries, is beneficial to the development and the wealth of nations, possibly even if free-trade policies are not shared with all trading partners. This perspective leads away from the classic interpretation of free trade as an international prisoner’s dilemma game in which every country has an incentive to introduce trade barriers as long as no other country follows this policy. As a matter of fact, the public choice approach to modeling trade barriers as a result of an intra-national PD game seems much more realistic. In a public choice model, trade barriers are explained by rent-seeking activities within a jurisdiction as compared to jurisdictions seeking to gain advantage over other jurisdictions.

Whatever the slowly vanishing political hindrances to free trade were and are, free trade is recognized as being beneficial to all citizens at least in the long run.

“From a constitutional perspective, the argument can be restated in terms of the distinction between the constitutional and the sub-constitutional or in-period level of choice: If we were made to choose between alternative institutional-constitutional regimes, a free-trade regime on the one side, and a regime characterized by pervasive protectionism on the other side, we would certainly prefer to live in the former because it would promise to be the wealthier society. Such choice at the level of regimes, would reflect, what one may call our constitutional preferences, our preferences over alternative constitutional rules, preferences that are informed by our perception of the working properties of alternative constitutional systems“ (Vanberg 1992, 379)

If choices were made in such a binary environment, it would certainly be in the best interest of the constituents to vote for a free-trade regime, given that they are interested in increased wealth. Presenting free trade as the “best” constitutional choice in such a fashion, however, neglects potential conflicts with other interests. Choices are seldom binary in nature and even though free trade as a general rule might be a more likely outcome under a veil of uncertainty than the choice of a protectionist regime, this theoretical prediction ignores the possible tensions between other constitutional preferences. Before turning to this crucial issue, the concept of normative individualism needs to be presented.

2. Normative Individualism

Normative individualism is based on the hypothesis that the preferences, interests and value judgements of individuals are the only relevant criteria to evaluate rules and policy choices. The institutional task (ordnungpolitische Aufgabe) that follows from normative individualism is the construction of an order that is highly responsive to individual preferences. The market mechanism as coordination mechanism meets this criterion better than any other system for individual decisions. Nevertheless, choices exist that principally can not be chosen within the market. That is choices concerning the rules of the game can principally not be addressed within the game. Collective or constitutional choices are ideally brought about by a democratic process. To fulfill the requirements of normative individualism, the responsiveness of the collective as well as the individual decision system has to be maximized. Responsiveness to individual preferences is maximized if the responsiveness in the collective as well as in the individual system is maximized and additionally the choice between the two decision modes is possible. The possibility to choose collectively, either because the choice systematically cannot (yet) be made individually or because the principals just decide to do so, needs to be continually guaranteed.

3. Constitutional Choice and Barriers to Trade

Imagine two jurisdictions, one (jurisdiction A) that has constituents who are highly interested in the preservation of the environment and the other (B) where the constituents are indifferent to environmental degradation. The constituents making up jurisdiction A therefore implement a wide variety of incentives for industry within their jurisdiction to preserve the environment. Pollution and environmental degradation are kept to a minimum due to tradeable permits, taxes and regulations. Industry located in jurisdiction B is not restricted in the use of the environment as a production factor. Since constituents in both countries are familiar with basic economic trade theory, they would like to engage in free trade.

If the country of origin principle applies , the constituents in A must accept the influx of lower priced goods produced in B at higher costs of environmental degradation. In this situation, it is easy to envision jurisdiction A requiring some sort of labeling on jurisdiction B's products. Labeling, so the argument goes, assures consumer sovereignty and protection. If the constituents of A have a preference for environmental protection, they will simply not buy B's products. This "solution," however, reduces the constituents' power from "consumer-voter" to mere "consumer"; there are several reasons why this might not be appropriate.

Since identical goods produced with divergent ecological consequences have different costs, competition between producers in jurisdiction A and B would be distorted. Companies operating within the country with the higher environmental standards would probably not be able to sell at the same price than a company producing in a low standard country ceteris paribus. Whatever the respective cost structures may be  competition regarding environmental factors is not in the interest of the constituents of jurisdiction A (race to the bottom). Without appropriate trade framework, environmental protection is merely viewed as a cost factor. The industry in A has higher costs because they produce the joint product environment.
It becomes obvious that constituents in A have differing views of what a trade barrier might be than constituents of jurisdiction B. The important part, however, is that economic theory cannot resolve this problem. Economists can merely present the trade-off of varying policies. They could point out, for instance, that even though free trade, is not a priori good, it has high instrumental value in generating wealth. Constituents, however, must decide what choices they want to make and on what level they want to make them.

4. The Role of Competition as a Discovery Procedure

As mentioned before, more sophisticated definitions of free trade exist. In those definitions, environmental problems as discussed above would be excluded. According to such a broader definition, differing environmental standards inhibiting free trade would not be regarded as trade barriers because they reflect preferences that systematically couldn’t be expressed individually. Safety requirements for cars are a good example. If a person has a preference for some general level of traffic safety, it is not enough for that person to have the individual choice between cars with high safety standards and those without. Since overall traffic safety not only depends on this person´s individual choice, but is also affected by externalities arising from other people´s choices, individuals face a dilemma. Even if they are interested in general traffic safety, the structure of the decision environment will systematically prohibit an equilibrium where all individuals choose a car with high safety requirements. The existence of externalities creates the incentive to free ride on the public good general safety.  More sophisticated definitions of free trade take potential dilemma structures into account and admit that constitutional choices, which might conflict with free trade as a general rule, are appropriate. A sophisticated version of free trade theory therefore takes into account the existence of trade barriers due to public goods. In all other cases, this theory seems to follow the narrow definition for two main reasons.

The first reason is that collective choices tend to limit competition. Limited competition between alternative uses of factors and goods, however, is generally recognized as detrimental to economic performance. Hayek has pointed to another somewhat ignored feature of market competition, namely its function as a discovery procedure. Competition does not only induce entrepreneurs to be responsive to predefined consumer tastes, but it generates the knowledge of what those preferences and tastes are. Since we can never know what the preferences of consumers as well as voters are, competition provides a powerful tool to discover and track changing preferences and to achieve them in an efficient way.
The second reason why some social scientists prefer a narrow definition of free trade is due to their suspicions of collective decision making. Public choice theory has emphasized the limits of collective and constitutional choice processes in establishing a sensitive link between citizens’ interests and governmental policies. Following from this, Vanberg (1992, 385) argues that “the principle of free trade can considerably strengthen the power of control that citizens, as individuals, are able to exercise vis-a-vis their governments.“ This argument, first fully presented in Tiebout (1956) and previously addressed by Hayek (1948), has become a standard concept in competitive federalism. Exit, in the language of Hirschmann, or "voting with the feet" in Tiebout's terminology, represents an important feature of federalism. This feature, namely that individuals can choose between jurisdictions individually and thereby control the constitutional framework to some extent, without making potentially biased collective or constitutional choices is however not a perfect substitute for collective or constitutional decision making. More choices on the individual level is far from being a perfect compensation for the loss of being able to make collective/constitutional choices. Competition between regimes could certainly play a positive role in creating a higher responsiveness of governments to the preferences of their constituents; the question of within which framework this competition will occur in, however, remains unclear.

Whatever the specific issue, it becomes clear that there is no reason to categorically deny constituents the possibility of choosing whether they want to decide an issue on a constitutional, collective or individual level. Even considering efficiency and exit arguments, and the possibility that collective decision making, as the Public Choice School suspects, might not be highly responsive to constituents preferences, the issue cannot be decided on these grounds without violating normative individualism.

Although I am convinced that most decisions that can be made individually should not be made collectively, I do not think that this represents an a priori case against collective decisions even in cases involving no public good. Meritorious goods, an old expression stemming from welfare economics, describes private goods that are institutionally transformed into public goods for normative reasons (higher education in Germany is an example of a meritorious good). Whether it is in the constituents best interest to choose individually or collectively (and thereby turn the good into a meritorious good) has to be decided on a case by case basis, for there are no a priori insights that would enable us to form a positive decision without normative inputs from constituents.

5. The Role of “Ordo“ as Determining the Type of Competition

Given the considerations of competition as a process of discovering preferences as well as an efficient means to produce them, we have to turn back to the classics. Adam Smith pointed to the necessity of an institutional structure to ensure the performance of the invisible hand. His "science of the legislator" was further developed and put into practice almost 200 years later by Walter Eucken (1992) and the Freiburg School. Eucken’s main contribution was the insight that competition and market transactions in general need a stable framework. His idea of "ORDO" as a normative concept defining the rules within which dynamic entrepreneurs could interact was fundamental to the economic order of Germany. Competition can therefore only be as good as the framework within which it occurs is. The economic order determines whether dynamic entrepreneurs are competing by warfare, boycotting and destroying each other’s factories or by prices and by seeking out new factor combinations and creating new products. What is true for the economic order of a jurisdiction is also true for the international order determining the economic relationship between jurisdictions. The benefits of free trade largely depend on the constitutional order within which trade occurs. ORDO is a normative concept that is defined - at least in democratic, self-governing societies - by the preferences of the constituents of the involved jurisdictions. Only competition within this normative order guarantees high economic efficiency and satisfaction of the preferences of the involved constituents.

6. A Priori versus Self-Governing Choices

In the following, I will briefly present five cases that demonstrate potential conflicts between free trade and constituents´ preferences. At least two of the cases directly violate standard free trade theory in the sense that collective or constitutional solutions are preferred over the possibility of individual choice.
European countries have heterogeneous norms and regulations with respect to trade, that now, because of the European Union, need to be adjusted to create a truly common market. Conceptually, the problem has been to seek and define European rules and regulations in order to replace separate national policy and law. This "Faustian bargain" (Ostrom 1997) which is intended to benefit the EU by leading to freer trade and higher wealth, could cause the complete destruction of national and local governance structures and violate normative individualism. In order to avoid the consequences of a complete harmonization as a further step towards a European "Leviathan", the principle of mutual recognition (Gegenseitige Anerkennung) has been introduced by EU legislation. This principle allows member states to preserve to some degree their own rules and standards. German citizens, for instance, can prevent imports from France through the federal government if those imports do not meet German standards concerning the environment, health, or consumer safety. In cases where the imports do not deviate from regulations and norms concerning these aspects, the imports cannot be legally stopped. An important precedent supporting free trade was the “Cassis de Dijon“ verdict, which held that products lawfully produced and distributed in any member state must be allowed in any other member state. This rule is defined in Art. 30 and 100b of the EC-treaty (EG-Vertrag) and is intended to allow free trade within the European community. This treaty between all member nations (EG-Vertrag) can be interpreted as a constitutional choice for a European Union without trade barriers. Even though qualifications to free trade are rare in the economic literature (see Vanberg 1992 for an exception), the European Union established several exceptions, where nations can successfully prevent the imports. If environmental, health, security or consumer protection issues are involved, mutual recognition can be challenged. As several law suits particularly those in the food industry show, it is often sufficient to label products in order to circumvent possible import restrictions. Thus both the treaty and judicial practice proscribe that as a general rule the constituents of individual member states can choose what products they want only on an individual level. Constitutional level choices are denied as long as they do not pertain to the realm of direct public interest as defined by the European Commission.

Even though the principle of mutual recognition has advantages over a policy of strict harmonization, it violates normative individualism. The European Union decides a priori what constitutes a trade barrier. The EU follows the underlying doctrine that choices that can be made at an individual level should not be decided on a collective or a constitutional level. As a result, constituents´ collective and constitutional preferences are ignored as long as they do not fall under one of the categories representing possible exclusion of the general free-trade rule.

A similar case (Handelsblatt 1998), violating the ecological and animal protection preferences of American citizens, is the decision of the World Trade Organization (WTO) that overturned the US import restriction on shrimp harvested without verification that turtle excluding devices (TED's) had been used in the process. TED's which are mandatory for American shrimpers, prevent turtles from becoming entangled in the nets and drowning. The WTO ruled against the US restriction from May 1996 stating that the TED requirement was an illegal trade barrier much to the pleasure of Malaysia, India, Pakistan and Thailand that would have been the primary losers of the ban.

The quest of Quebec for cultural preservation is another case where free trade as a general rule conflicts with constitutional preferences. The constituents of Quebec want to preserve French as the main language of communication. In order to achieve this, several protectionist measures have been taken. From a public choice perspective, those measures are explained only in terms of rent seeking behavior on the part of local companies trying to maintain low levels of competition. This perspective, however, ignores that cultural preferences are involved. It may well be the case that the constituents of Quebec would be willing to incur a loss in wealth in order to preserve their cultural identity.
The possibility that constituents might prefer to choose collectively as opposed to individually is clearly demonstrated in the case of flame-retardant pyjamas for children. What began as a domestic problem, resulted in choices that would also affect import regulations. After a child died because his pyjamas caught on fire, the US government, pressured by popular demand, instituted a labeling law requiring that all children’s pyjamas carry a visible label stating whether they were flame retardant or not. According to the normative bias of standard theory, labeling should have resolved the problem. However, when another child tragically died after his pyjamas caught on fire and the mother had declared that she had thought that all childrens' pyjamas were now flame retardant, the US banned all pyjamas that were not fire retardant. This ban included imported pyjamas that did not meet the standards established by the regulation.

A fifth case demonstrating potential problems of jurisdictional competition without proper constraints within which such competition can take place is Sweden. Last year, the tariff on tobacco was dramatically raised within the Swedish market, which caused a surge in both smuggling and electronic tobacco purchases on the Internet. Since the price for tobacco in Sweden is approximately 100 percent higher than on the Internet, total government revenues from the tax on tobacco declined drastically. This demonstration of the direct correlation between Internet trade and Swedish collective choices decreases the self-governing capabilities of Sweden.

This turn of events has forced the Swedish government to make the decision to cut the tax on tobacco in order to capture the tax-based revenue associated with regular tobacco sales. How long can Sweden, a relatively small market with a twenty-five percent value added tax (VAT), continue to place these tariffs on retail sales, when the Swedish consumer is now purchasing on the Internet at lower, more competitive prices? Again, assuming that the tariff on tobacco represented a constitutional choice of the constituents of Sweden (which in this particular case might be an inappropriate assumption), the Internet allows every constituent to circumvent his constitutional choice. The Internet represents a foreign jurisdiction from a Swedish perspective that easily allows Swedish consumers to vote with their feet. Since constitutional choices are no longer binding, constituents of Sweden are not capable of choosing collectively to impose a tariff on tobacco on normative grounds. To use a classic analogy from Constitutional Political Economy, Ulysses is not tied to the mast by constitutional choice if he has the possibility to free himself from the ropes with the well-known consequences.

All five cases presented here show that free trade as a constitutional choice can severely impinge on the self-governing capabilities of jurisdictions. Free trade as a constitutional choice can conflict with other constitutional choices. The lack of analysis of this problem in the literature is due to a normative bias towards individual decision making. This bias is understandable since individual decision making is taken as a mechanism of pure preference revelation as opposed to collective action, which is not systematically unbiased (see Downs 1957 for a classic example). If preferences can be revealed individually, it is regarded as a "pretense of knowledge" if elected representatives try to solve the problem. In representative democracies, where constitutional decisions are not taken collectively as is theoretically implied, there is a risk that collective and constitutional rules will be enacted that do not correspond to constituent preferences. However, this risk does not justify a priori judgements. The level of decentralization is in itself a normative question that cannot be treated as a positive one. In most cases, properly informed constituents would probably want to keep collective decisions to a minimum, thereby recognizing the instrumental value of free trade, but scientific arguments cannot provide a priori answers, as science can inform us only about the trade-off involved, not about constituent preferences.


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