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
(VERSION WITHOUT FOOTNOTES)
Abstract
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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