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

Abstract:     
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 forgoing the benefits of 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.

Number of Pages in PDF File: 41

Keywords: First-best versus second-best policy, free trade, government's commitment, signalling and strategic trade policy

JEL Classification: F13

working papers series