Working Paper: CEPR ID: DP2731
Authors: Dermot Leahy; J. Peter Neary
Abstract: The theory of strategic trade policy yields ambiguous recommendations for assistance to exporting firms in oligopolistic industries. Some writers have, however, suggested that investment subsidies are a more robust recommendation than export subsidies. We show that, though ambiguous in principle, the case for investment subsidies is reasonably robust in practice. Except when functional forms exhibit arbitrary non-linearities, it holds under both Cournot and Bertrand competition, with either cost-reducing or market-expanding investment, and with or without spillovers. Only if firms have strong asymmetries in their investment behaviour and engage in Bertrand competition is an investment tax clearly justified.
Keywords: cost-reducing investment; export subsidies; market-expanding investment; R&D subsidies; strategic industrial policy; strategic trade policy
JEL Codes: F12; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| investment subsidies (H23) | increased home investment (R21) |
| increased home investment (R21) | reduces foreign investment (F21) |
| reduces foreign investment (F21) | raises home profits (D33) |
| investment subsidies (H23) | raises home profits (D33) |
| investment subsidies (H23) | robust under Cournot and Bertrand competition (D43) |
| strategic substitutes (C72) | investment subsidy justification (H20) |
| asymmetries between firms (F12) | optimal policy change (C61) |
| investment spillovers (F23) | robustness of investment subsidy policy (H23) |