STRATEGIC EXPORT PROMOTION IN THE ABSENCE OF GOVERNMENT PRECOMMITMENT

Arguments in favor of a strategic trade policy are based on the assumption that the government can credibly precommit to a policy that will not be altered, even if it is suboptimal ex post. This paper examines the implications of relaxing this assumption; to this end, a three stage game is considered that accounts for the sunk costs associated with capacity installment. It is found that-contrary to common belief-the time-consistent optimal subsidy level is positive, though generally lower than the optimal level with precommitment. This somewhat counterintuitive result is driven by the commitment value of capacity.