DP2731 Robust Rules for Industrial Policy in Open Economies

Author(s): Dermot Leahy, J Peter Neary
Publication Date: March 2001
Keyword(s): Cost-Reducing Investment, Export Subsidies, Market-Expanding Investment, R&D Subsidies, Strategic Industrial Policy, Strategic Trade Policy
JEL(s): F12, L13
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2731

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.