American Economic Review: Vol. 98 No. 4 (September 2008)


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Trade Policy and Loss Aversion

Article Citation

Freund, Caroline, and Caglar Ozden. 2008. "Trade Policy and Loss Aversion." American Economic Review, 98(4): 1675-91.

DOI: 10.1257/aer.98.4.1675


We develop a political economy model where loss aversion and reference dependence are important in shaping people’s preferences over trade policy. The policy implications of the augmented model differ in three ways: there is a region of compensating protection, where a decline in the world price leads to an offsetting increase in protection, such that a constant domestic price is maintained; protection following a single negative price shock will be persistent; and irrespective of the extent of lobbying, there will be a deviation from free trade that favors loss-making industries. The augmented model explains protections of the US steel industry since 1980. (JEL F13, F14, L61)

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Freund, Caroline (World Bank)
Ozden, Caglar (World Bank)

JEL Classifications

F13: Trade Policy; International Trade Organizations
F14: Country and Industry Studies of Trade
L61: Metals and Metal Products; Cement; Glass; Ceramics

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