Saturday, 16 February 2008

Why governments pick losers ... or do they? (updated)

Earlier I blogged on Why do governments back losers? Two parts of an answer. I now learn that there is a NBER working paper from a few years ago in which Richard E. Baldwin and Frederic Robert-Nicoud argue its not so much that government policy picks losers, it is that losers pick government policy. The paper is Entry and Asymmetric Lobbying: Why Governments Pick Losers, NBER Working Paper No. 8756, January 2002.

Baldwin and Robert-Nicoud point out that governments that try to pick winners and losers usually choose the latter. They note that governments intervene to support many industries but a large proportion of such support goes to the ailing sectors of the economy.
In the US and Europe, the most protected sectors – agriculture, textiles, clothing, footwear, steel and shipbuilding –have all been in decline for decades. Counter examples are rare. Even when a growing sector gets protection, such as the US semiconductor industry, the protection tends to focus on market segments – like memory chips – in which the domestic industry is losing ground.
In their paper Baldwin and Robert-Nicoud try to explain this outcome via a lobbying model that allows for entry and sunk costs.
At the heart of the pressure-group approach is the presumption that special interest groups (SIGs) who spend the most on lobbying or other political activities are, other things equal, the ones that get the most government support. In this light, the success of sunset industries in winning a disproportionate share of government support is paradoxical. After all, lobbying dollars of expanding industries should be just as welcomed by politician as those of declining industries and an industry’s ability to finance lobbying expenditures and its interest in obtaining government support should be positively related to its size, employment and/or profitability; one would expect the highest levels of government support in the biggest and strongest sectors rather than in ailing sectors.
The basic story behind the Baldwin and Robert-Nicoud model is the notion that government policy is influenced by pressure groups and such lobbying is costly. But SIGs need to incur these costs in order to create rents that they hope to appropriate.
There is, however, a strong asymmetry in the ability of expanding and contracting industries to appropriate the benefits of lobbying. In an expanding industry, policy-created rents attract new entry that erodes the rents. In the extreme, free and instantaneous entry obviates all rents. This is not true in declining industries. Since sunk market-entry costs (e.g., unrecoverable investments in product development, training and brand name advertising) create quasi-rents, profits in declining industries can be raised without attracting entry as long as the level of quasi-rents does not rise above a normal rate of return on the sunk capital.
This asymmetry in the appropriability of rents creates an asymmetry in the incentive to lobby. The upshoot being that losers lobby more and harder. This, in turn, means that government policy is more influenced by losers, that is,
... government policy doesn’'t pick losers; losers pick governments policy.
Baldwin and Robert-Nicoud note that a corollary to this reasoning accounts for the tendency of SIGs to fight harder to avoid losses than they do to win new gains.

(HT: Tim Harford)

Update: Not PC gives an example of Losers picking losers

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