Geographic politics, loss aversion and trade policy: The case of cotton in China. (9th November 2021)

• Record Type: Journal Article
• Authors: Yan, Wenshou; Huang, Kaixing
• Is Part Of: World economy. Volume 45:Number 9(2022)
• Page Start: 2854
• Page End: 2881
• Publication Date: 2021-11-09
• Subjects: loss aversion -- politically sensitive products -- trade distortion; International economic relations -- Periodicals; 330
• DOI: 10.1111/twec.13222
• Languages: English
• ISSNs: 0378-5920

Abstract

Abstract: This paper seeks to explain how China's trade policy responses to world price fluctuations by considering the role of loss aversion and reference dependence. In order to analyse the effect of loss aversion on trade distortion in one‐party dominated countries where monetary contribution may not be feasible, we modify the model of Freund and Özden ( A merican Economic Review, 2008, 98, 1675) to obtain a model in which loss aversion no longer works through monetary contribution but through political supports from politically sensitive groups. We then test the theoretical predictions by using data from China's cotton sector. The modified theoretical model predicts that loss aversion and reference dependence still have effects on the trade distortion in countries where monetary contribution may not be feasible and that the trade distortions are higher (lower) when the world price is lower (higher) than the targeted domestic reference price, which measures reference dependence. Our empirical evidence from China's cotton sector supports these theoretical predictions.