Despite the impressive growth of literature on strategic export subsidies, realistic models of dynamic games that allow for repeated price, output and other decisions against the background of an evolving state variable like R&D or capital stocks seem to be entirely missing. In Discussion Paper No. 1405, Costas Lagopoulos and Research Fellows Konstantine Gatsios and Tryphon Kollintzas take a step in this direction. They consider a time-dependent stochastic dynamic extension of the standard model in which both governments and firms must make current decisions as part of a plan about future decisions ad infinitum. The dynamic structure of the game emanates either from an exhaustible resource or from a learning-by-doing technology, while its stochastic nature stems from uncertainty about future demand and cost conditions.

A time-consistent solution of the model is obtained where governments are allowed to influence future outputs only through their current subsidies and not through their announcements regarding future subsidy levels. The authors carry out a number of simulation exercises, using the model with different sets of parameter values. One important feature emerging from these exercises is that subsidies, after initially jumping to positive levels, are gradually reduced to zero in the exhaustible-resource case, while they keep rising in the learning-by-doing case. Another interesting result is that subsidies in the time-inconsistent equilibrium tend to be higher than in the time consistent case. Subsidies are also higher in the learning-by-doing than in the exhaustible resource specification, and are higher in the case where only one government is active. Welfare comparisons indicate small differences between time-consistent and time-inconsistent equilibria.

Time-Consistent Solutions to the Stochastic Dynamic Strategic Export Subsidy Problem
Konstantine Gatsios, Tryphon Kollintzas and Costas Lagopoulos