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Industrial subsidy policy and the optimal level of specialization

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  • Dubey, Ram Sewak
  • Kang, Minwook

Abstract

Despite compelling rationale based on the theory of comparative advantage for free trade, many countries adopt restrictive trade practices. In this paper we investigate this puzzle in a stylized two-country two-good Ricardian model of international trade. Governments can offer protection to domestic industries via industrial subsidy policy in this model. We prove the existence of a Nash equilibrium in the two-player game where industries choose the level of specialization. We determine the necessary conditions for complete specialization in (a) the free-trade regime; and (b) the protectionist regime implemented through industrial subsidy policy. Our results show that if the government intends to promote complete specialization, then a high degree of comparative advantage and a large elasticity of substitution between export and import goods are required. Empirical evidence on these two parameters indicate that complete specialization is unlikely to survive in the protectionist regime.

Suggested Citation

  • Dubey, Ram Sewak & Kang, Minwook, 2020. "Industrial subsidy policy and the optimal level of specialization," Economic Modelling, Elsevier, vol. 91(C), pages 81-88.
  • Handle: RePEc:eee:ecmode:v:91:y:2020:i:c:p:81-88
    DOI: 10.1016/j.econmod.2020.05.025
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    References listed on IDEAS

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    More about this item

    Keywords

    Comparative advantage; Complete specialization; Free trade; Industrial subsidy; Protectionism;
    All these keywords.

    JEL classification:

    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • F20 - International Economics - - International Factor Movements and International Business - - - General

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