Working Paper: CEPR ID: DP2937
Authors: Eugenio J. Miravete
Abstract: Can a government induce efficiency gains in domestic industry by protecting it against foreign competition? Would such trade protection be time-consistent? The present Paper builds a dynamic equilibrium model that accounts for learning-by-doing effects that link firms' strategies over time. The model shows that the existence of dynamic economies of scale suffices to overcome the traditional government's lack of commitment to its tariff policy. This Paper compares the infinite horizon Markov Perfect Equilibria of this game with the dynamic equilibrium under commitment as well as the static Nash equilibrium. Equilibrium strategies are derived in closed form by solving a linear-quadratic differential game. Optimal trade policy involves higher tariff levels than in the static setup in order to account for future gains in efficiency.
Keywords: Infant Industry; Infinite Horizon; Markov Perfect Equilibria; Linear Quadratic Differential Games; Tariff Protection
JEL Codes: C73; F12; F13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government tariff policies (F13) | Domestic industry efficiency (L69) |
| Learning-by-doing effects (J24) | Domestic industry efficiency (L69) |
| Dynamic economies of scale (F12) | Domestic monopolist's marginal costs (D42) |
| Domestic monopolist's pricing decisions (D42) | Government's tariff schedules (F13) |
| Government's lack of commitment (H11) | Extended protection (G52) |
| Extended protection (G52) | Undermining of infant industry argument (O25) |