Industrial subsidy policy and the optimal level of specialization

Ram Sewak Dubey, Minwook Kang

Research output: Contribution to journalArticlepeer-review

Abstract

Despite compelling rationale based on the theory of comparative advantage for free trade, many countries adopt restrictive trade practices. In this paper we investigate this puzzle in a stylized two-country two-good Ricardian model of international trade. Governments can offer protection to domestic industries via industrial subsidy policy in this model. We prove the existence of a Nash equilibrium in the two-player game where industries choose the level of specialization. We determine the necessary conditions for complete specialization in (a) the free-trade regime; and (b) the protectionist regime implemented through industrial subsidy policy. Our results show that if the government intends to promote complete specialization, then a high degree of comparative advantage and a large elasticity of substitution between export and import goods are required. Empirical evidence on these two parameters indicate that complete specialization is unlikely to survive in the protectionist regime.

Original languageEnglish
Pages (from-to)81-88
Number of pages8
JournalEconomic Modelling
Volume91
DOIs
StatePublished - Sep 2020

Keywords

  • Comparative advantage
  • Complete specialization
  • Free trade
  • Industrial subsidy
  • Protectionism

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