One should keep in mind that our discussion is relevant in the short term,
since in the long run strategic trade policy may induce further effects. First, new
domestic firms may endogenously enter in the foreign market and drive net prof-
its to zero.12 Moreover, in a more general model, export promoting policies may
create asymmetries in the domestic markets (which are absent in our model).
While these aspects are beyond the scope of the present paper, they should be
kept in mind as possible limitations for our outcomes. Second, other countries
could retaliate introducing export promoting policies as well. This important
extension is left for further research,13 but it may represent a limitation of our
case for export promoting policies in a long term perspective. Nevertheless, in
line with the related literature, we believe that it is important to realize which
are the short run strategic incentives to promote exports in alternative contexts,
since policymakers are often more myopic than they should be. In Appendix B
I present a more genaral analysis of optimal export promotion and, following
Grossman and Helpman (1994), of the political economy considerations which
may lead policymakers.
2 Trade Policy
In this section I will apply our general results to the theory of strategic trade
policy. I will derive the optimal strategic unilateral trade policy in different
models. The focus will be on specific subsidies, but similar results could be
obtained with ad valorem subsidies. Finally, I will briefly consider other forms
of export promotion.
of each firm would not change and the strategic incentive to promote exports would just be:
SI = nH h0(z)πH πH3
∏Hι - h0(z)∏H2
The economics behind this result is interesting: under free entry there is not a terms of
trade effect induced by an export promoting policy (which is present with entry barriers; see
Dixit, 1984): as we will see in the applications, domestic firms just crowd out foreign firms.
The same would happen if a limited number of other countries would promote its own exports:
as long as free entry holds on other firms, these countries would adopt the same policy and
share the benefits of export promotion.
12Venables (1985) studies a particular example of this case. See also Markusen and Venables
(1988). Brander (1995) summarizes the results on entry for the reciprocal-markets model.
13 In such a war, all countries would want to promote exports of their firms, but, contrary
to the case with barriers to entry, there cannot be a symmetric equilibrium, because all firms
would make zero profits and each government would prefer not to promote exports anymore.
However, there can be asymmetric equilibria were some countries promote exports and other
do not. More interestingly, these equilibria may be Pareto efficient compared to free trade
with free entry, since they would increase production or lower prices in the foreign country,
while providing some profits to exporting countries.