Lobbying, trade, and misallocation

Abstract

This paper studies how lobbying affects welfare gains from trade in a second-best world. I develop an open economy model of heterogeneous firms that can lobby to influence firm-specific distortions. As trade costs decline, exporters increase lobbying due to the complementarity between market size and lobbying benefits, impacting allocative efficiency, firm entry, and consequently gains from trade. I estimate the model using an IV strategy and indirect inference with US firm-level data. Gains from trade are 4% higher with lobbying, driven by larger improvements in allocative efficiency as more productive exporters increase lobbying, mitigating their initially unfavorable exogenous distortions. However, when selection is driven by exogenous distortions, trade may cause welfare losses exacerbated by lobbying. These findings suggest that firms’ micro-level adjustments matter for gains from trade.