Kiel Working Papers, Kiel Institute for World Economics
No 1853:
Contingent Trade Policy and Economic Efficiency
Phillip McCalman, Frank Stähler and Gerald Willmann
Abstract: This paper develops an efficiency theory of contingent
trade policies. We model the competition for a domestic market between one
domestic and one foreign firm as a pricing game under incomplete
information about production costs. The cost distributions are asymmetric
because the foreign firm incurs a trade cost to serve the domestic market.
We show that the foreign firm prices more aggressively to overcome its cost
disadvantage. This creates the possibility of an inefficient allocation,
justifying the use of contingent trade policy on efficiency grounds.
Despite an environment of asymmetric information, contingent trade policy
that seeks to maximize global welfare can be designed to avoid the
potential inefficiency. National governments, on the other hand, make
excessive use of contingent trade policy due to rent shifting motives. The
expected inefficiency of national policy is larger (smaller) for low (high)
trade costs compared to the laissez-faire case. In general, there is no
clear ranking between the laissez-faire outcome and a contingent national
trade policy
Keywords: Contingent Trade Policy, Efficiency; (follow links to similar papers)
JEL-Codes: F12,; F13; (follow links to similar papers)
36 pages, July 2013
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