Strategic Trade Policy with Incompletly Informed Policymakers

Strategic Trade Policy with Incompletely Informed Policymakers Abstract Ever since the inception of research on strategic trade policy, economists have warned that the informational requirements are high, and unlikely to be met in practice. This paper investigates the implications of incomplete information for a simple, rent-shifting trade policy of the type proposed in Brander-S pencer (I98S). It finds that asymmetric information undermines the precommitment effect of unilateral government intervention, due to the requirements of incentive compatibility. This screening effect induces a downward distortion in the optimal subsidy, which may be so great as to require a tax rather than a subsidy for the least efficient firms, given a zero-profit participation constraint. Second, in contrast to the full-information case with strategic substitutes, the introduction of a rival interventionist government reinforces rather than countervails the precommitment effect, by reducing the incentive for the domestic firm to misrepresent its private information. Finally, the paper introduces a novel nonmtervention-profit participation constraint to take into account the special relationship between firms and policymakers in trade; in this case, the government targets the efficient firms with fositive subsidies, and eschews intervention altogether for the least efficient firms.