Strategic Protective Trade Policy under Asymmetric Information

Abstract

Recently, strategic protective trade policies are emerging. The strategic choices are a result of asymmetric information on demand parameters and a firm’s cost structure. In this paper, we will suggest the optimal policy of eliciting private information from domestic firms. The policy is a contract of menus, comprising a tariff and a production subsidy (henceforth, subsidy). When one domestic firm and another foreign firm compete in a duopolistic domestic market, we consider unilateral intervention of the domestic government. The domestic firm privately holds information on the industrial cost structure. The main findings are as follows. First, the two policies can be equivalent conditionally. We will provide conditions for equivalence. Second, the domestic firm has an incentive to misreport the industrial cost structure to the government. Using a menu of a tariff and a subsidy (in combination with a lump-sum transfer), the government can screen the domestic firm’s marginal cost. That is, the menu leads the domestic firm to disclose private information.