6. Strategic Export Policy Unless stated otherwise: no domestic consumption of export good. 6.1 Competitive Foreign Conduct Assumptions: Perfect Competition in domestic country Constant marginal costs = export supply curve Optimal export quantity Xm: intersection of MC and MR, obtained via tax t = distance between points 2 and 3 in figure 6.1 Gießen, 03.12.2009

Figure 6.1 Gießen, 03.12.2009

Imperfect competition in domestic country: Price between MC and PM. Same outcome can be achieved by a domestic pure monopolist or an export cartel charging the monopoly price (only legal cartel in USA). Imperfect competition in domestic country: Price between MC and PM. Perceived marginal revenue greater than true marginal revenue: Oligopolists impose externality on competitors (business stealing effect) Optimal tax: difference between perceived and true marginal revenue. Main result: For competitive foreign conduct the optimal export policy is a tax on domestic exports (not a subsidy). Gießen, 03.12.2009

Figure 6.2 Gießen, 03.12.2009

6.2 Profit Shifting Cournot Duopoly: domestic and foreign firm compete in a third country, no domestic consumption. Total profit smaller than monopoly profit. Domestic firm could increase her profit by acting as Stackelberg leader – however, committment problem. Government policy could solve this problem (Brander and Spencer 1985). Gießen, 03.12.2009

Figure 6.3 Gießen, 03.12.2009

pd(x,x*) = p(x +x*) demand for given foreign sales. Government has first mover advantage: export subsidy shifts reaction function of the domestic firm to the right, Stackelberg equilibrium can be achieved, profit increase greater than subsidy. Justification for government intervention: Divergence of private marginal revenue from social marginal revenue. pd(x,x*) = p(x +x*) demand for given foreign sales. po(x,c*) = p(x +*(x,c*)) „true“ demand function Gießen, 03.12.2009

Figure 6.4 Gießen, 03.12.2009

Figure 6.5 Gießen, 03.12.2009

Intersection of pd and po at equilibrium quantities of the Cournot-game. po is more elastic than pd. Figure 6.6: Point 3 depicts Stackelberg equlibrium, point 1 the Cournot-equilibrium. Point 3 can be reached as equilibrium by reducing MR by subsidy s which equals the difference between perceived and true marginal revenue. Perceived MR at Xm may be above true MR ( tax) or below true MR ( subsidy)), depending on degree of competition abroad and number of domestic firms. Gießen, 03.12.2009

Figure 6.6 Gießen, 03.12.2009

6.3 Price Competition Quantity competition  subsidy optimal if domestic industry is sufficiently concentrated (monopoly). Price competition: Subsidies are never desirable. Quantities (Cournot): strategic substitutes (= downward sloping reaction functions). Prices (Bertrand): strategic complements (= upward sloping reaction functions). Subsidy shifts reaction function to the left – profits decline  tax on exports increases domestic and foreign profits. Gießen, 03.12.2009

Figure 6.7 Gießen, 03.12.2009

Comparing Figures 6.5 and 6.8: Cournot-competition: Perceived demand function less elastic than true one. Bertrand-competition: Perceived demand function more elastic than true one. Figure 6.9: Optimal export tax for one domestic firm. For many firms tax increases: price increase raises sales of other domestic firms. Gießen, 03.12.2009

Figure 6.8 Gießen, 03.12.2009

Figure 6.9 Gießen, 03.12.2009

6.4 Entry with increasing returns Assuming fixed costs and free entry implies an increase of the number of domestic firms and therefore an increase of total domestic fixed costs  reverses positive effect of subsidies even with Cournot-competition. If the number of firms is determined by zero profit condition optimal strategic policy is an export tax. Gießen, 03.12.2009

6.5 Resource constraints Partial analysis: Subsidy (export tax) if perceived marginal revenue is smaller (greater) than true MR. Two export goods, each needs one unit of a constrained input („scientist“) per unit of ouput. Figure 6.10: Equilibrium allocation of scarce resource at intersection of perceived MRs, efficient allocation at intersection of true MRs  industry 2 should increase output. Gießen, 03.12.2009

Above rule would suggest subsidy for industry 1 – would move the equilibrium away from the efficient allocation. Optimal policy: Closing the gap between points 2 and 3 via a suitable combination of taxes and subsidies. Gain from optimal policy smaller than suggested by partial analysis (shaded triangle, not entire triangle from the move from 1 to 2) Gießen, 03.12.2009

Figure 6.10 Gießen, 03.12.2009

Two-Way Export Policies Two-stage game: Stage 1: each government chooses export subsidy Stage 2: firms play Cournot-game Equilibrium: both countries subsidize, welfare smaller than without export subsidies Prisoners‘ dilemma Co-operative solution: both countries impose export taxes. Gießen, 03.12.2009

Figure 6.11 Gießen, 03.12.2009

Bertrand game (see figure 6 Bertrand game (see figure 6.12): In equilibrium both countries impose export taxes  welfare higher than without government intervetion. First best: Point 3 – too little intervention. Gießen, 03.12.2009

Figure 6.12 Gießen, 03.12.2009

6.7 Consumption Effects Definition of Welfare changes: dW = dpXf + (pc  c)dXd + (p  c)dXf ToT + cons.wedge + prod.efficiency effect No imports dW = [d(pXf )  cdXf ]+ (pc  c)dXd First best policy tries to achieve for Exports: True marginal revenue equal to marginal cost Domestic consumption: price equal to marginal cost Gießen, 03.12.2009

Satisfaction of domestic demand: Expand production Reduce Both conditions together imply that true marginal cost of exports equals domestic consumer price. Satisfaction of domestic demand: Expand production Reduce In the optimum: both are equally costly. Example: Cournot competition and fixed number of firms. Export policy: tax equal to difference between true and perceived marginal return (subsidy) Gießen, 03.12.2009

Export policy: tax equal to difference between true and perceived marginal return (subsidy) sf. Without domestic consumption: equivalence of production and export subsidy. Optimal consumption: pc(Xd) + pc‘(Xd)Xd/n = c‘(Xd + Xf) − sd Subsidy of domestic consumption equal to markup. Alternative: subsidy of domestic production equal to sd, export tax equal to sf − sd Gießen, 03.12.2009