The Dynamic Politics of Policy Instruments

Legislators may disagree on when intervention is appropriate, but they tend to agree as to what interventions are inefficient. Nevertheless, when regulating international trade, food security, environmental protection, or redistribution, governments oftentimes intervene with inefficient instruments such as distortionary taxes and quotas. We show that, despite the availability of an economically inefficient policy in a dynamic setting with shocks to the environment, an inefficient policy instrument can be selected by fully rational parties when these parties disagree on when an intervention is desirable. Intuitively, intervening via an inefficient instrument makes repeal of the intervention more likely when the need for an intervention decreases, and thus makes the less interventionist party more inclined to intervene in the first place. This effect is more pronounced in volatile environments: parties tend to postpone the inefficient resolution of a problem when the future is more uncertain. Further, there are conditions under which statically inefficient instruments can be Pareto improving. Finally, we apply our findings to shed some light on underutilization of the 'double dividend'.