Strategic Trade Policy under International Price and Quantity Competition

A standard critique of the strategic, two-stage industrial and trade policy models is that trade policy recommendations depend on the nature of competition between firms. Brander and Spencer (1985) have shown that under quantity competition in an international market governments opt for export subsidies to maximize national welfare. However, as shown by Eaton and Grossman (1986), trade policy conclusions are different if there is Bertrand price competition instead of Cournot quantity competition. Then the optimal trade policy is to tax exports. In these two papers production is for a third country and the governments act strategically to distort free trading. The interesting question is therefore, whether their propositions on opposite trade policy recommendations do also hold if the assumption of no home consumption is dropped. Since the case of no home consumption is anyway not very realistic, we will check the robustness of the propositions under price or quantity competition when goods are consumed domestically with intra-industry trade between the two competing countries. The purpose of this paper is to investigate whether trade policy always switches from export subsidy to export tax if firms engage in Bertrand competition instead of Cournot competition with trade between the two countries. In section 2 we will show that an export subsidy is optimal also under intra-industry trade. In section 3 we will characterize market structures and types of goods where an export subsidy is even optimal under Bertrand price competition. In Section 4 we will use the same model to derive inducements for import tariffs (or subsidies) if the nature of competition is Bertrand Section 5 concludes the paper.