eThesis - Kauppakorkeakoulun sähköiset gradut

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SPECIAL INTEREST GROUPS AND ENDOGENOUS POLICIES – A REVIEW OF COMMON AGENCY MODELS

The purpose of the study is on one hand to go through the different ways to model the political economy of policy formation, and on the other hand to take a critical look at the most commonly used model, namely that of Grossman and Helpman, in order to analyse how it performs in capturing the mechanics of policy formation in general sense.

The economics literature refers to a situation in which an agent takes an action that simultaneously affects several principals as a relationship of common agency. In such situations, the principals typically design payment schedules that give the agent an incentive to take their interests into account. Bernheim and Whinston (1986) have formalized this menu-auction game in a general framework. The contribution of Grossman and Helpman was to apply the menu-auction framework to model trade policy making. Later on, their common agency model has found several applications on other policy areas.

This study takes first a retrospective look at endogenous policy models by setting the Grossman-Helpman model as the starting point. The focus is then shifted to models that have emerged after the introduction of the Protection for Sale article. Two main questions arise: how does the Grossman-Helpman model relate to earlier research on ndogenous policies, and how has the common agency tradition evolved in the theoretical literature during the past decade? The study is conducted in the form of a literature review with an emphasis on theoretical research literature.

As a result of the survey, it can be concluded that the Grossman-Helpman model offers a rich and flexible way to model endogenous policies. In comparison to earlier research, it does not suffer from black boxes which, in contrast, are the burden of tariff-formation and political support models. However, the Grossman-Helpman model is far from being a complete picture of real world interactions in the political arena. The common agency literature that builds on the Grossman-Helpman model includes studies with for instance endogenous lobby formation, asymmetric information, and hierarchical governments. Each of these offers several modelling possibilities and new insights of the political game. Some other augmented versions of the basic model, such as dynamic settings, multiple agents, non-quasilinear preferences and the inclusion of a foreign government, are also briefly revised. Issues that still lack a proper treatment in common agency models include for instance the multiplicity of influencing channels, the role of feelings and emotions, the importance of credibility and reputation as well as the specificities of different political regimes.

Key words: Trade policy, Political economy, Lobbying, Special interest, Common agency, Menu auction, Endogenous policy