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Strategic Trade Policy Notes

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Pip Reeve IEMT10W4T3 Does the theory of strategic trade policy explain why developed countries have protectionist policies?
It seems that 'countries often perceive themselves as being in competition with each other for profitable international markets.' 1 For this reason, trade policy has recently attempted to understand the relationship between international firms more fully with somewhat more realistic assumptions. So, 'strategic trade policy is defined as trade policy that conditions or alters a strategic relationship between firms, implying that strategic trade policy focuses primarily on trade policy in the presence of oligopoly.'2 In this essay, I will use game theory to discuss the decisions faced by governments about whether or not to intervene, and how to intervene. I will then discuss in some detail the politics behind strategic trade policy and whether or not this suggests that developed countries should have protectionist policies. To begin with, I will discuss, using game theory, the choice faced by the government in deciding whether to intervene or not. For example, consider a game with two firms and a domestic government. If the government is able to act first, they can choose either to intervene or not intervene. In each cell of this payoff matrix (adapted from Brander 1995); the first number is the payoff to firm x; the second number is the payoff to firm y and the third number is the payoff to the government. Government chooses to intervene: Firm y Y1 Y2 Firm x X1 2 0 0 2
-1 X2 3 0 1
-1 0 2*
Government chooses not to intervene: Firm y Y1 Y2 Firm x X1 1 1 0 0 2 0
X2 2 0 3 -2 1 1 If the government chooses the option to intervene, the sub-game perfect equilibrium will be the lower left hand corner. A 'Nash equilibrium arises when all players choose strategies such that each player's strategy maximises that player's payoff, given the strategies chosen by other players.' 3 The lower left hand corner is not a Nash equilibrium as firm Y would choose the higher level of output, Y 2. If the government chooses not to intervene, the sub-game perfect equilibrium would be the upper right hand corner (X1 and X2). Every cell in the intervention matrix has a lower domestic welfare (government) payoff than the no intervention matrix. For this reason, the government will choose to intervene as they will have a payoff of 2 rather than 0. In this case, 'the national benefit comes about entirely because of the government ability to alter the strategic interaction between the two firms.' 4 However, there are several important assumptions that must be made. For example, the government must have information about the payoffs of all the firms, and must be able to 'credibly commit to its policy choice before the firms make their choices.'5

1 'Export subsidies and international market share rivalry' Brander & Spencer 1984 2 'Strategic Trade Policy' Brander 1995 3 'Strategic Trade Policy' Brander 1995 4 'Strategic Trade Policy' Brander 1995 5 'Strategic Trade Policy' Brander 1995

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