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The design of industry-specific trade policies and a sequential entry-exit model of international trade

University of British Columbia

Conventional trade theory assumes perfect competition among firms and makes on balance a strong case for free trade. An important observation in the modern international economy is that competition among firms in many industries is imperfectly competitive. These firms, usually few and large, strategically interact with each other and may earn supernormal profits. As shown by the recently growing literature on trade with imperfect competition, allowing for the importance of imperfect competition leads to new insights about causes, effects, and patterns of trade, and has major implications for the analysis of trade policy as well. This study investigates the effects of firms' imperfect competition on trade policy designs and on trade patterns, product variety, and specialization. The thesis consists of two parts. The first part is entitled "The design of industry-specific trade policies" and the second part "A sequential entry-exit model of international trade". The first part of the thesis addresses the following two questions: (l) Whether government intervention can raise the national welfare and how important the effect of intervention would be in raising welfare; and (2) Whether, or when, trade restrictions are first-best policies, and when other policy instruments would achieve the same aims more efficiently. Dixit (1985) has recently undertaken an empirical study of strategic trade policy for a specific industry. The rivalry between the U.S. firms and Japanese firms in the U.S. passenger car market is examined. It is noticed that in Dixit's work, only the numerical (simulation) results are given and evaluated, and only the U.S. government is assumed to be active in policy-making. The purpose of the first part of the thesis is to provide a theoretical treatment of Dixit's model, to discuss the role of policy intervention and compare the importance and efficiency of tariffs vis-a-vis domestic production subsidies under different market structures, and to examine the consequences of allowing Japan to be active in policy-making. The basic results of this part are as follows. First, when the domestic (foreign) firms' conduct has rather significant effects on the market equilibrium relative to the foreign (domestic) firms', policy is usually directed by the domestic (foreign) firms' monopoly in the market, and a domestic production subsidy (a tariff) is usually more important and more efficient than a tariff (a domestic production subsidy). Secondly, allowing Japan to simultaneously pursue its optimal policy can reverse the result of positive U.S. welfare gains from the optimal policies, a result obtained under the condition that Japan adopts complete laissez-faire. Furthermore, Japan does have an incentive to pursue the optimal policy. Thus, The U.S. policy gains are not at all automatic or riskless. This result is obtained by examined the non-cooperative Nash equilibrium in tariff/subsidy for the U.S. and Japan. Thirdly, both countries would nonetheless be better off if they could cooperatively choose policy parameters to maximize the joint welfare rather than non-cooperatively pursue their own optimal policies. The two countries may play a bargaining game. The purpose of the second part is to examine firms' strategic behaviour in international rivalry, and its effects on trade pattens and on product variety by using a sequential entry-exit model of trade. The paper models an industry consisting of two firms, each in a different country. The two firms are assumed to be able to potentially produce and export two imperfectly substitutable products, to be able to make their entry, exit, and production (quantity, price, etc.) decisions sequentially, and to be able to choose these strategy variables for each country separately. Two four-stage games are constructed and examined. The paper intends to do an exploration of models of international trade. The new feature of our model is that the fixed cost of withdrawing a product is considered as a variable and firms are allowed to exit in response to entry. Three basic results emerge from the second paper. First, firms' strategic behaviour can give rise to two-way trade in identical products which are produced only for trade. The kind of two-way trade can introduce products which would otherwise not be produced in autarky. The non-cooperative solution to the firm's profit-maximizing problem involves such a two-way trade, but each firm may nonetheless be better off if the two firms could agree not to invade each other's home markets. This result is more likely to hold as exit costs are low, as transport costs are small, as products are better substitutes, as competition in identical products is more intense, and as firms are more likely to treat different countries as different markets. Secondly, our model gives mixed results on the issue of whether trade, through intra-industry trade, makes a greater variety of products available to consumers. Whether trade increases or reduces variety depends on the firms' payoffs of various market structures and on the level of entry, exit, and transport costs. Firms' strategic interaction through trade in order to maximize profits can increase or reduce product variety. In the case of Cournot or Bertrand conduct with linear demand, trade would increase product variety. Moreover, changes in variety can be brought about by either an actual flow of trade or a potential for trade. Finally, instead of producing all substitutable products and monopolizing their home markets, firms may specialize in some products and invade each other's countries. So the third result is in favour for intra-industry trade, and it also shows specialization can be independently caused by the rivalry of oligopolistic firms.

Text

2010-06-14

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http://hdl.handle.net/2429/25719

Business Administration

University of British Columbia

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