DP3946 Does 'Non-Committed' Government Always Generate Lower Social Welfare then its 'Committed' Counter-Part

Author(s): Kresimir Zigic
Publication Date: June 2003
Keyword(s): first versus second best strategic policy, government commitment, optimal tariffs and subsidies, technological spillovers
JEL(s): F13, L11, L13, O31
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3946

We compare the social welfare generated by a domestic government in two types of policy set-ups: a ?commitment? regime in which government sets its policy instrument before the strategic choice by a domestic firm and a ?non-commitment? regime where the policy variable is set after the firm?s strategic choice. The government implements strategic trade policy in the form of optimal tariffs under which domestic and foreign firms compete in quantities in an imperfectly competitive domestic market where cost reducing R&D spillovers take place from the domestic to the foreign firm. We show that the ?non-committed? government generally achieves a higher welfare and levies a lower optimal tariff than the ?committed? government. Moreover, when the domestic government is allowed to use an R&D subsidy, which may or may not be accompanied by the optimal tariff, the resulting optimal subsidies are always positive.