Xenia Matschke

Labor market imperfections are commonly believed to be a major reason for imposing trade impediments. In this paper, I introduce labor market rigidities that are prevalent in continental European countries into the well-known protection for sale model proposed by Grossman and Helpman (1994). I show that contrary to commonly held views, imperfections in the labor market do not necessarily increase equilibrium trade protection. A testable equilibrium trade protection equation is also derived. The findings in this paper are hence particularly relevant for empirical tests of trade policy determinants in economies with more regulated labor markets.

This article tests the Protection for Sale (PFS) model using detailed data from US food‐processing industries under alternative import‐demand specifications. All empirical results support the PFS model predictions and previous empirical work qualitatively. However, a surprising result is that we obtain weights between 2.6 and 3.6 for domestic welfare using import slopes or elasticities derived from domestic demand and supply functions. In contrast, results based on directly specified import demands (including the Armington model) yield the usual, unrealistically large estimates for the domestic welfare weight. We contend that this empirical paradox arises mainly because the explanatory variables tend to be extremely large for industries with low import ratios and/or low import elasticities (or slopes) resulting from relatively volatile import prices. The results with derived import parameters point to a much stronger role of campaign contributions within the PFS model than previously found.