Abstract
Brander and Spencer (1985) suggested that a subsidy policy for export could improve national welfare. Such a policy instrument is called strategic trade policy. But, it is used to say that strategic trade policy allows domestic firms strategic behavior, and that it may cause welfare less than under free trade. Kydland and Prescott (1977) claimed that higher welfare might be achieved by previously selected rules than by state-contingent governing discretion, for the former permits a rational-expected agent no room for strategic operations.
Essentially, any prior-determined subsidy policy by the government, including free trade, forbids firms' strategic action. But, if the authorities do not have a perfect credibility, the remaining agents anticipate that it might change its strategy announced already, and they will maneuver their situation into a position which they prefer. Therefore, it is understood that not preceding decision by the administration but its credibility restricts the others' strategic activities. A complete credibility and no credibility are equivalent to rules and discretion, respectively. I analyze the situation under between zero and full level of the credibility of the government.
The model is a four-stage game. First, the home government announces some subsidy program, given a certain credibility level. Second, a domestic firm chooses its cost-cutting investment. Third, renegotiation on subsidy happens depending on the credibility level. Last, the home firm competes a la Cournot with a foreign firm in an export market.
Increasing credibility proves to cause higer welfare. Then, I will investigate how much the welfare decreases at small credibility. Intuitive reasoning says that a policy-making government always achieve higher welfare than a nation with no governmental authorities does. But, it follows that the government with small credibility causes, by the optimal policy, welfare worse than the non-governing nation does if the national exporter has larger strategic incentives by smaller investment costs. Furthermore, it might happen that negative welfare results from even larger incentives to invest, meaning that it is worse than under no trade.
