Quality standards under classical oligopoly and trade : regulatory protection or just over-regulation

Abstract

Recent trade policy debates have focused increasingly on the supposed barriers caused by di¤ering country regulations, and at proposed remedies such as mutual recognition agreements. There are several motives for setting minimum quality standards in an open economy. This paper examines the motive of correcting an undersupply of quality when an industry is monopolistic, and sets up a theoretical model of regulatory setting of minimum vertical quality standards in a classical two-country cross-hauling duopoly model with identical �rms and consumers. It is shown that, in the absence of cooperation between the two national regulators, there will be a tendency to strategic over-regulation, bene�ting consumers at the expense of �rms compared to the globally optimal solution. This overregulation leads to excessive, rather than inadequate trade. Further, when a mixture of horizontal and vertical quality standards is introduced, the pro�t-shifting incentive noted in previous studies to set horizontal technical barriers to trade which discriminate against foreign suppliers is either greatly reduced or totally eliminated. It is also noted that the commonly-supported policy response to technical barriers to trade, mutual recognition, is not socially optimal as previous studies had indicated, but instead leads to underregulation, with higher-than-optimal company pro�ts and lower consumption and trade