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TIME-CONSISTENT PROTECTION WITH LEARNING BY DOING
(Click above to download a pdf copy of the paper)
- Abstract: Can a government induce efficiency gains in his domestic industry by
protecting it against foreign competition? Would such trade protection be
time-consistent? The present paper builds a dynamic equilibrium model that
accounts for learning-by-doing effects that link firms' strategies over
time. The model shows that the existence of dynamic economies of scale
suffices to overcome the traditional government's lack of commitment of its
tariff policy. This paper compares the infinite horizon Markov Perfect
Equilibrium of this game with the dynamic equilibrium under commitment as
well as the static Nash equilibrium. Equilibrium strategies are derived in
closed form by solving a linear--quadratic differential game. Optimal trade
policy involves higher tariff levels than in the static setup in order to
account for future gains in efficiency. Under reasonable assumptions, the
unique stable MPE is characterized by a domestic price and tariff that
decrease as experience accumulates, thus supporting the future liberalization
of trade as an equilibrium feature of this dynamic game.
- Publication: European Economic Review, 47, 761-790 (lead article), October 2003.
- JEL: C73, F12, F13.
- First version: July 1994.
- Final version: July 2002.
- Funding: Fundación Ramón Areces and Spanish Ministry of Education and Science..
- Seminars: Northwestern University and University of Pennsylvania.
- Conferences: XIII Latin
American Meeting of the Econometric Society, Caracas 1994 and the 1st Conference on
Empirical Investigations in International Trade, Purdue University, 1994.
- Noteworthy: Previously circulated as CEPR DP No. 2937.
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