DP2928 Free Trade versus Strategic Trade as a Choice Between Two 'Second-best' Policies: A Symmetric versus Asymmetric Information Analysis

Author(s): Delia Ionascu, Kresimir Zigic
Publication Date: August 2001
Keyword(s): first-best versus second-best policy, free trade, government's commitment, signalling, strategic trade policy
JEL(s): F13
Programme Areas: Industrial Organization, International Trade and Regional Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2928

In this Paper, we analyse the following policy dilemma: strategic trade policy versus free trade when the domestic government is bound to intervene only after the domestic firm's strategic variable is chosen. This intervention allows the domestic firm to manipulate the domestic government and results in a socially inefficient choice of the strategic variable. Commitment to free trade leads, however, to foregoing the benefits from profit shifting. Yet, from the social point of view, free trade may be optimal even under the assumption of symmetric information. Due to costly signalling, this result is reinforced in the case of asymmetric information.