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Rivalry In Uncertain Export Markets: Commitment Versus Flexibility

By Gerda Dewit and Dermot Leahy

Abstract

This paper examines optimal trade policy in a two-period oligopoly model, with a home and a foreign firm choosing capital and output. Demand uncertainty, resolved in period two, gives rise to a trade-off between strategic commitment and flexibility in the firms’ investment decisions. When the government can commit to an export subsidy, it may choose to over- or under-subsidise to deter private-sector capital commitment. When the government chooses its trade policy flexibly, the relative value of commitment to the unsubsidised foreign firm is greater than to the subsidised home firm. Finally, a flexible subsidy regime is compared to free trade.Demand Uncertainty; Strategic Commitment; Flexibility; Trade Policy.

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