Reciprocal Dumping under Dichotomous Regulation

An essential ingredient to net-zero-emissions policies is to regionally integrate electricity markets. But electricity cross-border trades are often assessed as inefficient. We explain this inefficiency by the presence of a dichotomous regulation: producers are highly regulated with regard to their local activities, but weakly regulated when it comes to their exports. Such a dichotomy in regulation can be generalized to every economic sector, with varying intensity. We develop a generic 2-player 2-stage game theoretical framework where producers anticipate the impact of their exports on the clearing of regulated local markets. We characterize the subgame-perfect Nash equilibrium of the game as a function of the relative price-elasticity between markets. Overall, dichotomous regulation leads producers to over-export in order to create scarcity in their home market. Hence, despite that local markets clear efficiently, the global equilibrium is inefficient. When the two jurisdictions are relatively symmetric, the equilibrium is Pareto-dominated by the first-best outcome. These results call for better coordination between regulators across different jurisdictions.