The Optimal Penal Code vs. Infinite Nash Reversion in Trade Liberalization
Posted: 13 Aug 1998
This paper derives Abreu's (1986) stick-and-carrot strategy optimal penal codes in a partial equilibrium model that has been widely used to examine trade liberalization. Unless the asymmetry between countries is significant, the optimal penal codes take simple form. It is also shown that the difference between the most-cooperative pairs of tariffs supported by two schemes, the optimal penal code and infinite Nash reversion, crucially depends on the size of the surplus from exports that a deviating country forgoes when the other country places an embargo, rather than the (punitive) optimum tariff, on imports in the punishment.
JEL Classification: F13
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