Asymmetric Competition Among Nation States: A Differential Game Approach

Posted: 20 Mar 2012

See all articles by Yutao Han

Yutao Han

Universite du Luxembourg

Patrice Pieretti

Universite du Luxembourg; Centre de Recherche en Économie Appliquée (CREA)

Skerdilajda Zanaj

Catholic University of Louvain - Center for Operations Research and Econometrics (CORE)

Benteng Zou

Centre de Recherche en Économie Appliquée (CREA)

Date Written: February 22, 2012

Abstract

This paper analyzes the impact of foreign investments on a small country's economy in the context of international competition. To that end, we model tax and infrastructure competition within a differential game framework between two unequally sized countries. The model accounts for the widely recognized characteristic that small states are more flexible in their political decision making than larger countries. However, we also acknowledge that small size is associated with limited institutional capacity in the provision of public goods. The model shows that the long-term outcome of international competition crucially depends on the degree of capital mobility. In particular, we show that flexibility mitigates against - but does not eliminate - the likelihood of collapse in a small economy. Finally, we note that the beneficial effect of flexibility in a small state increases with its inefficiency in providing public infrastructure and with the degree of international openness.

Keywords: Tax/Infrastructure competition, Open-loop/Markovian strategies, Differential games

JEL Classification: H25, H73, O30, O43

Suggested Citation

Han, Yutao and Pieretti, Patrice and Zanaj, Skerdilajda and Zou, Benteng, Asymmetric Competition Among Nation States: A Differential Game Approach (February 22, 2012). Institute of Mathematical Economics Working Paper No. 460, Available at SSRN: https://ssrn.com/abstract=2026184

Yutao Han

Universite du Luxembourg ( email )

L-1511 Luxembourg
Luxembourg

Patrice Pieretti (Contact Author)

Universite du Luxembourg ( email )

L-1511 Luxembourg
Luxembourg

Centre de Recherche en Économie Appliquée (CREA) ( email )

Campus Limpertsberg
162A, avenue de la Faïencerie
Luxembourg, 1511
Luxembourg

Skerdilajda Zanaj

Catholic University of Louvain - Center for Operations Research and Econometrics (CORE) ( email )

34 Voie du Roman Pays
B-1348 Louvain-la-Neuve, b-1348
Belgium

Benteng Zou

Centre de Recherche en Économie Appliquée (CREA) ( email )

Campus Limpertsberg
162A, avenue de la Faïencerie
Luxembourg, 1511
Luxembourg

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