Trade and Industrial Policy under Imperfect Competition

Abstract

Trade and industry Anthony Venables and Alasdair Smith The textbook model of international trade is set in a world of perfectly competitive markets where products are homogenous and economies of scale are absent. Yet empirical evidence of two-way trade in similar products and of the importance of scale economies suggests this model is unrealistic. This paper examines the implications of imperfect competition for trade and industrial policy and evaluates the robustness of the conventional recommendation of free trade. Although policy design should be sensitive to the degree of competition, some general and intuitive principles emerge. Good policies target and promote activities which imperfect competition had previously overrestricted. Since trade affects the degree of competition in domestic and foreign markets, it is important that trade, industrial, and anti-trust policy should be complementary. To quantify these insights, the paper develops empirical models of two industries, refrigerators and footwear, which are then used to compare the effects of trade policy (tariffs or export subsidies), with or without foreign retaliation, and industrial policy (a production subsidy). Free trade is rarely the best policy. Whilst some forms of subsidy benefit some or even all countries, reciprocal tariffs are likely to harm the world economy. A strong rationale remains for negotiated and reciprocal reductions in trade barriers.

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