Targeted export promotion with several oligopolistic industries

Abstract

In this paper we ask whether a policy of targeted export promotion can raise domestic welfare when several oligopolistic industries all draw on the same scarce factor of production. Our point of departure is one of Cournot duopoly in which a single home firm competes with a single foreign firm in a market outside the horse country. It has been shown previously that when there is only one such industry in an otherwise perfectly competitive world economy, a subsidy policy by the home government transfers profits to the domestic firm, and thereby raises domestic welfare. However, when many such industries (and only these) utilize the same inelastically supplied resource, promotion of one bids up the return to the specific factor, and consequently disadvantages all of the non-targeted industries in their respective duopolistic competitions. Our question then is which industry(s), if any, is worthy of promotion. We find that, when the specific factor is used in fixed proportion to output, and all of the duopolies have similar demand and cost conditions, a policy of free trade is optimal. We identify the conditions for welfare improvement when a single industry is selected for targeting under asymmetric conditions, and also investigate whether a uniform subsidy to all industries in the imperfectly competitive sector will raise domestic welfare.

Strategic Trade Policy in General Oligopolistic Equilibrium

“…To better illustrate the source of general equilibrium feedbacks, take the following simple example from Dixit and Grossman (1986). Consider a country in which two sectors compete 5 Brander and Spencer (1984b), as much of economic literature, claimed that their model of STP could be embedded in a general equilibrium framework.…”

“…I revisit the issue of factor market linkages among sectors, highlighted by Dixit and Grossman (1986), using the general oligopolistic equilibrium (henceforth GOLE) approach (Neary, 2003b;c). The main feature of this approach is that of assuming a continuum of sectors, each with a small number of firms competingà la Cournot.…”

“…The key finding of Dixit and Grossman (1986) is that, within a third-country framework with many Cournot duopolies having constant marginal costs, free trade is optimal. Applying an export (or production) subsidy, as prescribed by Brander and Spencer (1985), to all sectors aiming to move all domestic firms towards a condition of Stackelberg leadership, gives no benefit to anyone.…”

“…This policy would bid up the domestic factor reward of the inelastically supplied factor of production by the same amount of the subsidy. Dixit and Grossman (1986) suggested to select specific sectors with the strongest potential in improving domestic welfare and to discourage those sectors with the weakest potential. Hence, in absence of an efficient targeting criteria, it would appear that their work weakens the profit-shifting argument of STP.…”

“…In the main part of their model, Dixit and Grossman (1986) worked up with an exogenously given foreign factor reward, so that foreign firms do not face any resource constraint. Their analysis focused on the domestic labor market.…”