Document Type

Preprint

Publication Date

9-1-2020

Journal / Book Title

Economic Modelling

Abstract

Despite compelling rationale based on the theory of comparative advantage for free trade, many countries adopt restrictive trade practices. In this paper we investigate this puzzle in a stylized two-country two-good Ricardian model of international trade. Governments can offer protection to domestic industries via industrial subsidy policy in this model. We prove the existence of a Nash equilibrium in the two-player game where industries choose the level of specialization. We determine the necessary conditions for complete specialization in (a) the free-trade regime; and (b) the protectionist regime implemented through industrial subsidy policy. Our results show that if the government intends to promote complete specialization, then a high degree of comparative advantage and a large elasticity of substitution between export and import goods are required. Empirical evidence on these two parameters indicate that complete specialization is unlikely to survive in the protectionist regime.

DOI

10.1016/j.econmod.2020.05.025

Published Citation

Dubey, Ram Sewak and Kang, Minwook, Industrial subsidy policy and the optimal level of specialization (May 26, 2020). Economic Modelling, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3190595 or http://dx.doi.org/10.2139/ssrn.3190595

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