DP2937 Time-Consistent Protection with Learning by Doing

Author(s):	Eugenio J Miravete
Publication Date:	September 2001
Keyword(s):	infant-industry, infinite horizon markov perfect equilibria, linear-quadratic differential game, tariff protection
JEL(s):	C73, F12, F13
Programme Areas:	Industrial Organization, International Trade and Regional Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=2937

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.