RESEARCH AND ANALYSIS
Free Trade Agreements and the Consolidation of Democracy
Xuepeng Liu (Kennesaw State University), Emanuel Ornelas (London School of Economics)
Over 200 free trade agreements have been formed since the early 1990s, according to the World Trade Organization. During this period the world has also witnessed increasing levels of democracy. Are these two phenomena independent from each other? We argue that they are not. There is evidence that participation in free trade agreements (FTAs) can destroy protectionist rents. If undoing FTAs is not costless, they serve also as commitment devices to destroy future protectionist rents. Since such rents are attractive for autocratic groups, FTAs can lower their incentives to seek power. While this has little value in established democracies, where the rule of law is strong and the risk of authoritarian disruption is negligible, it can be very important for unstable democracies. Trade gains aside, these threatened states should therefore be particularly keen to seek involvement in FTAs.
We provide the theoretical basis for our claims by extending the trade integration model developed by Ornelas (2005) to allow for endogenous changes in the political regime. At any trade regime domestic firms exchange contributions for protection with the government, which cares about national welfare and the contributions it receives. A similar game takes place at the ex ante stage, when the government defines whether to form an FTA. The key to understanding the impact of an FTA is the recognition that the equilibrium of the (ex post) external tariff game changes with the constraint imposed by the agreement on the internal tariffs. Taking this into account, one can show that, even though an FTA still permits lobbying for protection against excluded countries, the volume of protectionist rents falls with the formation of the agreement.
In a dynamic setting this implies that, all else equal, groups motivated mainly by rents obtained while in office will have lower incentives to seek power if the country is deeply engaged in FTAs. Authoritarian groups tend to fit this description best. After all, due to their aptitude to resort to violence rather than to rely on accountability to keep power, authoritarian groups have lower incentives to pursue policies that favor the population at large than democratic ones. If the gain of authoritarian groups from keeping power are lower when the country is engaged in FTAs, while the costs and risks from attempting a coup d’état are unaltered by the agreements, the likelihood of democratic failure will, all else being equal, be lower if the country participates more intensively in FTAs.
Accordingly, if the incumbent government in an unstable democracy realizes this effect of “democratic consolidation,” it will seek participation in FTAs more actively than it would otherwise. The reason is two-fold. First, an FTA will weaken the authoritarian threat. Second, even if the dictatorial group takes control despite the FTA, the agreement will constrain its rent-extraction activities. Hence, we find that unstable democracies tend to enter in FTAs more frequently than other countries, all else being equal. In turn, participation in FTAs increases the likelihood of democracy survival in those countries.
One can, of course, always construct models that deliver strong theoretical results. The question is whether the model’s predictions are validated empirically. We rely on the strategy pursued by Persson and Tabellini (2009), who estimate the likelihood of democratic breakdown employing the concept of “democratic capital.” The domestic component of democratic capital takes into account the history of democracy in the country, while its foreign component considers current levels of democracy abroad. Along with other covariates, these two components of democratic capital allow us to estimate the likelihood of democratic failure in a country, which is one of our empirical challenges.
We find strong empirical support for both of our main theoretical results. Analyzing the formation of FTAs and the strength of democracy in 133 countries over 1948-2007, we find that greater participation in FTAs lowers the likelihood of democratic failure in a country. We find as well that a high risk of democratic breakdown induces countries to participate more actively in FTAs. Our empirical results are robust to many different econometric specifications as well as to different measures of democracy. The results are also economically meaningful--although they also make clear that FTAs are no panacea. For example, compared to Chile (an active participant of FTAs), the probability of democratic breakdown in Mongolia (the only WTO member not involved in any FTA) in 2005 would drop from 3% to 1% if Mongolia had the same level of FTA participation as Chile. Similarly, take the case of Guatemala from 1966 to 1967, when its out-of-democracy hazard increased from 0.6% to 6.2%. According to our estimates, this should lead to an increase of 2.25 percentage points in Guatemala’s FTA import share (the actual increase was 2.65 percentage points).
Our analysis also indicates that the rent destruction forces of FTAs are the main drivers of our results. For example, our predictions hold consistently for full-fledged agreements, signed according to GATT’s Article XXIV, which requires free trade agreements to cover most of the trade among the involved parties and that they liberalize fully vis-à-vis each other. By contrast, the estimates are generally indistinguishable from zero for partial-scope preferential trade agreements. Since those arrangements, signed under the Enabling Clause of the GATT, allow for many exceptions and are often not fully implemented, they impose very few restrictions on the availability of rents from protection. It is also possible that FTAs help to maintain democracies not because of their rent destruction effects, but because of pressure from more democratic FTA partners. While this is a very plausible alternative mechanism, our empirical tests suggest that FTAs with more democratic partners are about as valuable for the sustainability of a country’s democracy as FTAs with less democratic partners.
Governments recurrently declare “promoting democracy and political stability” as a central force behind their trade agreements. Our analysis indicates that this may be more than cheap talk, and that the destruction of rents in FTAs can indeed improve the sustainability of democracies. While this is surely not the only reason, this force can nevertheless help to explain the puzzling outbreak of regionalism since the early 1990s, while also helping to rationalize the global democratic wave taking place during the same period.
This article is based on the working paper “Free Trade Agreements and the Consolidation of Democracy,”.
Ornelas, Emanuel (2005). “Rent Destruction and the Political Viability of Free Trade Agreements.” Quarterly Journal of Economics 120(4), 1475-1506.
Persson, Torsten and Guido Tabellini (2009). “Democratic capital: The nexus of political and economic change.” American Economic Journal: Macroeconomics 1(2), 88-126.
Emanuel Ornelas is a Reader (Associate Professor) in the Managerial Economics and Strategy Group at the London School of Economics. He is also an Associate Editor of the Journal of International Economics, a Research Fellow of the Centre for Economic Policy Research, and the Director of the Globalisation Programme at LSE’s Centre for Economic Performance. Dr. Ornelas holds a Ph.D. in Economics from the University of Wisconsin and has carried out extensive research on the political economy of the formation and the consequences of regional trade agreements, as well as on other topics related to international trade and theories of the firm. He has presented his work in numerous professional conferences and academic institutions and published his research in leading academic journals.
Xuepeng Liu obtained his Ph.D. in Economics from the Maxwell School at Syracuse University (USA). His research focuses on international trade and economic development. He is currently an assistant professor of economics at Kennesaw State University (USA).