Incompletely informed policymakers and trade policy in oligopolistic industries

Abstract

We study strategic trade policy design when governments are incompletely informed about the market demand. Two symmetric, homogeneous product Cournot firms, one in each country, compete in a third country market. Contrary to what common sense would suggest, we show that if governments are less informed on the stochastic market demand both countries will be better off. Also contrary to findings in the literature, we show that when the government is partially informed, although quantity controls would be optimal for both high and low levels of demand uncertainty, subsidies are preferred for intermediate levels. IThe well-known Brander and Spencer (1985) model shows that, under complete information, a government adopts an export subsidy if the domestic firm competes with a foreign firm in terms of quantity. Subsequently, many others along with Eaton and Grossman (1986), Neary (1991) and Klette (1994) have investigated related issues under complete information. 1 However, policymakers hardly have complete information on various aspects of the economic environment, such as the cost structure of firms, demand conditions, or the mode of competition. In response to this shortcoming, researchers have begun to consider the effects of asymmetric information on the choice of trade policy. 2 We contribute to this line of literature by investigating (i) whether a better informed government can implement strategic trade policies effectively to achieve higher welfare in the domestic country, and (ii) whether better (less) informed governments favor policies with less (more) flexibility and more (less) commitment as suggested by Cooper and Riezman (1989). It turns out that variations in the amount of

Choice of trade policy for international oligopoly with incomplete information

“…Although, in this case, firms have imperfect information about demand in the destination country, the signals firms received equip them with better information than policymakers. Caglayan and Usman (2004) further extend Caglayan (2000) to let both governments receive additional noisy signals about the true state in the third market, and they conclude that both exporting countries are better off if they are less informed about stochastic demand in the third market. Both extensions reach similar policy conclusions as in Cooper and Riezman (1989) that any pairs of policy instruments could form a Nash equilibrium in a choice of trade policy game.…”

“…This overly simplified assumption is not realistic for policymakers since they are unlikely to have full information about market conditions. In response to this concern, economists have been examining the effect of asymmetric information on strategic trade policy (see, for instance, Cooper and Riezman, 1989;Arvan, 1991;Shivakumar, 1993Shivakumar, , 1995Martimort, 1996, 1997;Grant and Quiggin, 1997;Maggi, 1999;Anam and Chiang, 2000;Caglayan, 2000;Caglayan and Usman, 2004;Creane and Miyagiwa, 2008;Antoniou and Tsakiris, 2014).…”

“…Caglayan (2000) andCaglayan and Usman (2004) also assume export quotas are always binding. In our model, export quota will always be binding for firm 1 since the true state of nature is not observable.…”

Export Subsidies and Exchange Rate Pass‐through

“…() determined that the optimal subsidy level is higher with higher levels of cost heterogeneity. There are various other papers looking at the trade policy issues under uncertainty on either demand or cost sides (see Cooper and Riezman, ; Qui, ; Shivakumar, ; Maggi, ; Brainard and Martimort, ; Caglayan and Usman, ). While the results vary depending on the environment modeled, the fundamental intuition is that export subsidies increase welfare through capturing rents from the foreign market and subsidies intensify as potential for rent capturing increases through, for example, increasing size of foreign market or increasing efficiency of own firm.…”