II. Efficient policymaking in global markets
C. Global market power and trade

2. Strategic trade behavior

    Applies to a situation of global oligopoly--when more than one country has global market power in the same industry
    Example: global aircraft: Airbus and Boeing

    This is where rivalry among industrial nations is most likely
    The world as a whole gains by exploiting economies of scale to lower unit production costs.
    As with computer chips
    So far, so good.

    But few producers
    => possible excess profits
    => extra gains for the producing country.

    Policy implication: Strategic trade policy: government policies designed to influence the trade behavior of other countries in order to capture a larger share of global gains from trade
    Preview: This possibility creates more abuse than wise use of government policy

    Recall our coverage of trade promotion via export subsidies: Exporter loses from overproducing, underconsuming and lower ToT
    It turns out that all these adverse effects can be worth it in a case of global oligopoly

    Example 1: R&D subsidies
    Classic analyses of theory: James Brander and Barbara Spencer:

    Based on game theory
    Basic idea: a subsidy might deter entry by a rival and leave the home producer with the market and the profits

    Basic scenario: New line of commercial aircraft
    --profits >0 if Boeing OR Airbus produces it
    --profits <0 if BOTH produce it

Round 1:

Round 2: EU offers Airbus a $30 million R&D subsidy:

Round 3: 80%: B=0; 20%: B=-25; B=0 to -25; EU: offer subsidy? Y/N
Round 4: Role = A=EU; B=US -- will you offer a subsidy?

    Example 2: Export subsidies
    Brander and Spencer analyses: an export subsidy might raise welfare under special conditions

    Xsub -->
    For sure: Lower trade price for exports, but...
    Maybe: Foreign rivals cut output, leaving the domestic firm with a larger share of the global market.
    Maybe: Profits rise, if profit gained from extra market share offsets profits lost from lower price.

Lessons:

    Lesson 1: strategic trade behavior can improve national welfare in theory
    --Airbus gains no matter what Boeing does, so it will definitely enter
    --Boeing may therefore not enter => EU gains the profits.

    Lesson 2: the outcome is highly uncertain in practice

    (1) The assisted firms may not really need help
    Ex: Japan's steel industry: Falling transportation costs may have been enough to make the industry worthwhile.
    Overkill from gov't promotion: steel industry earns lower than average return in Japan.
    If domestic firms dominate anyway, should restrict exports to improve ToT, not subsidize them

    (2) Foreign rival firms might not react as expected
    Ex: Boeing/Airbus: What if Boeing is a lower cost producer than Airbus; earns profits even if Airbus enters the market.
    So US gains while EU loses by entering a market that it suffers overall losses in 
    (ex here: payout = $25M but resulting profit for Airbus = $20M => $5M loss for EU)

    (3) Foreign governments are likely to behave strategically as well
    Ex: two countries which both X-subsidize.
    Market shares may not change but both over-export.
    Ex: R&D for HDTV: After Japanese success, EU and US closed off their markets to develop their own industry. (worked out better: Japan had gone analog and US went digital)
    Ex: market share struggles: world agriculture and Xsubs (US and Australia using Xsubs to sell dairy products in Asia in 1995): Main beneficiaries = importing countries in general.

    Conclusions seem weird in practice too: weird to be subsidizing a domestic monopolist
    General results: with the Cold War over, economic concerns have become much more prevalent in political discussions
    Important to see that there are, for large trading countries and trade blocs, pay-offs to manipulating global prices in your favor but, they are exploitative
    Your gains come at the cost of an even greater loss of welfare abroad
    And these days, it is equally easy for domestic and foreign investors to own shares of Airbus
    Ideally the temptation to use these policies should be avoided--a worthwhile goal of political negotiations

Overall lessons:

    1. In theory, there are circumstances in which trade policy can raise national welfare
    2. In practice, most trade policy is the result of special interest lobbying in which producers gain at the expense of national welfare
    3. So, in theory, unilateral trade liberalization would increase a country's national welfare
    4. But, in practice, that rarely happens because the winners are consumers with large total gains but small gains per person compared to producers

A policy remedy: the WTO
    1. can facilitate package deals that help our exporters which builds support
    2. can play a bad cop role to keep markets open and offset domestic special interests

D. The least you should know about The WTO
    handout

1. Little known facts

    (1) Decision making is by consensus
    --no Member present formally objects to the proposed decision

    (2) Members must abide by only the commitments they have agreed to: "bindings"
    --Schedules of Commitments
    --Example: 2002 legislation to increase farm subsidies--subsidies still under our commitments. It reversed part of the reduction passed in 1996.

    (3) Rulings arise only if a complaint is filed 
    --reactive, not proactive
    --Dispute Settlement Body (DSB) handles trade complaints 
    --rulings of a Dispute Settlement Panel can be overruled only by a "negative consensus"
        (consensus against adoption)
    --remedies: implementation / compensation / retaliation