portant for the promotion of fashion, design and food industries. Japan, Korea
and other East-Asian countries have implemented export promoting policies for
decades. Heavily protected South-American countries have tried to subsidize
manufactured products in which they could develop a comparative advantage
(and not only those). Even US has implemented strong forms of export sub-
sidization through tax exemptions for a fraction of export profits, foreign tax
credit3 and export credit subsidies.
It appears quite surprising that, in front of this, trade economists do not
have clear and unambiguous arguments to explain why export subsidies could
be the optimal unilateral trade policy.4 I provide such an argument, studying
a model of trade policy for a foreign market with free entry for international
firms. Notice that free entry is a realistic assumption since a foreign country
without a domestic firm in the market can only gain from allowing free entry
of international firms. Under free entry, export subsidization is always the best
unilateral policy both under quantity and price competition, or, more generally,
under strategic substitutability and strategic complementarity. The intuition is
simple. While firms are playing some kind of Nash competition in the foreign
market, a government can give a strategic advantage to its domestic firm with an
appropriate trade policy. When entry is free, an incentive to be accomodating is
always counterproductive, because it just promotes entry by other foreign firms
and shifts profits away from the domestic firm. It is instead optimal to provide
an incentive to be aggressive, that is to expand production or (equivalently)
lower the price, since this behaviour limits entry increasing the market share of
the domestic firm.5 As usual, this is only possible by subsidizing its exports.
The same argument can be applied to other forms of indirect export promotion,
as policies which boost demand or decrease transport costs for the exporting
firms: as long as these policies increase the marginal profitability of the domestic
firm, there is a strategic incentive to use them unilaterally.
Last but not least, governments undertake competitive devaluations with
the specific aim to support exporting firms. In spite of this, economic theory
is again ambiguous on the merits of these policies. The traditional Mundell-
Fleming model emphasizes the beggar-thy-neighbour effects of unilateral deval-
uations. However, the recent new open-economy macroeconomics shows that
these devaluations can be beggar-thy-self policies (Corsetti and Pesenti, 2001).6
Moreover, economists tend to underlie the perverse consequences that competi-
tive devaluations have in terms of inflationary bias and creation of self-fulfilling
3 See Desai and Hines (2003) on the impact of the EU complaint before the WTO against
these subsidies: share price of american exporters fell sharply on this news.
4See Boone et al. (2006) and Kovac and Zigic (2006) for a related discussion.
5The result is closely related with recent progress in the theory of market leadership (Etro,
2004; 2006c; 2007). For a lot of material on these issues see www.intertic.org.
6 This happens because in presence of imperfectly competitive markets and sticky prices,
they lower the purchasing power of domestic agents’income and this negative terms of trade
externality can more than offset the positive espansionary effect (due to the reduction of real
wages under nominal rigidities).