This paper develops a dynamic political-economy model of trade-policy hysteresis. Tariffs reduce innovation and competitiveness but generate short-run benefits for import-competing sectors, creating incentives for myopic policymakers to adopt protectionism. The interaction between myopic protectionist policy and slow-moving competitiveness generates two stable steady states: a low-tariff, high-competitiveness regime and a high-tariff, low-competitiveness regime. Although free trade is welfare superior, it is politically fragile. Temporary tariff shocks that sufficiently erode competitiveness can permanently shift political incentives toward protectionism, trapping the economy in a low-competitiveness equilibrium with persistently high tariffs and lower welfare. • Protectionism weakens firms’ innovation incentives and erodes competitiveness over time. • Myopic policymakers favor protectionism when competitiveness is low. • The interaction of protectionism, competitiveness, and political incentives generates two trade regimes. • Temporary tariff shocks can tip the economy from openness to persistent protectionism. • Free trade is welfare-superior but politically fragile.
David Lindequist (Wed,) studied this question.