This paper develops the implications of strategic trade theory for policies targeted at the quality of exports. The model involves a three-stage game in which an LDC and a developed country attempt to reposition their firms in product quality space through taxes and subsidies on investment. The two firms (one in each country) first make an investment determining the quality of their product and then compete on the basis of either Bertrand or Cournot competition in a third country export market. An important innovation is our consideration of asymmetric costs of investment in quality with the LDC firm potentially facing substantially higher costs. If this cost difference is sufficiently large, we show that there exists a unique pure strategy equilibrium in which the LDC firm (firm L) produces the low-quality product and the developed country firm (firm H) produces the high-quality product. The paper also makes a technical contribution by providing analytical proofs of concavity for the profit and welfare functions under specified conditions. If you need money you may take speedy cash payday loans to expand your abilities and opportunities to go anywhere or to whatever you like.
There are two basic considerations in determining the profitability of a particular location on the quality ladder. First, for a given difference between own quality and the quality of the rival firm, there is the profitability of the location based on revenue and the investment costs required to reach that quality. Higher quality products tend to command higher revenues, but this tends to be offset by the fact that the cost of investment in quality is increasing at an increasing rate. The second consideration is the extent of the gap between own quality and the quality of the rival firm, but the role played by this gap differs depending on the nature of product market competition. Under Bertrand competition, an increase in the quality gap or extent of differentiation of the products relaxes price competition, raising the profits of both firms, whereas under Cournot competition, the effect on profits depends on whether the firm is above or below its rival on the quality ladder. Under Cournot competition, firm H’s profit is increased by a reduction in the quality of firm L as before, but firm H responds to an increase in its own quality by sufficiently increasing output so as to cause firm L’s profits to fall. This difference in responses is at the heart of the explanation for the opposing policy prescriptions arising under the two market structures.
F or the LDC, strategic trade policy involves a subsidy to investment in quality under Bertrand competition and a tax under Cournot competition. At the Nash equilibrium in qualities, each firm takes its rival’s quality as fixed, but under both Bertrand and Cournot competition, firm H responds to an increase in LDC quality by also increasing quality so as to partially offset the narrowing of the quality gap. As a result, firm L in the LDC overestimates the extent to which the quality gap will narrow as it raises its quality. In the Bertrand case, since LDC profits are increasing in the quality gap, this causes firm L to position its product too low on the quality ladder. By contrast, in the Cournot case, firm L is better off as the quality gap narrows and it sets too high a quality. As is typical in strategic trade policy models, the government can increase domestic welfare by committing to its policy so as to shift the equilibrium to what would have been the outcome if the domestic firm could act as a Stackelberg leader in the absence of policy. Taking into account the reaction of the high quality firm, optimal LDC policy then involves an investment subsidy so as to move firm L (and hence firm H) up the quality ladder in the Bertrand case and an investment tax so as to move firm L (and firm H) down the quality ladder in the Cournot case. High quality firm may also require help, financial help nothing more. In such a way they may take a speedy cash payday loans on speedy-payday-loans.com to expand horizons.
Under Bertrand competition, the subsidy actually causes a narrowing of the quality gap, which hurts the profits of both firms by sharpening price competition. However, the increased LDC revenue from the improvement in quality more than offsets this. Similarly, the LDC gain from a move down the quality ladder under Cournot competition more than offsets the loss from the widening in the quality gap due to the tax policy.
Similar reasoning applies with respect to developed country policy, except that now the direction of incentives under the two forms of competition is changed. Thus the developed country has an incentive to tax investment in quality under Bertrand competition and to subsidize investment in quality under Cournot competition. One factor explaining this switch in policy is that the direction of the LDC firm’s response to an increase firm H’s quality depends on the nature of competition. Thus the LDC firm responds by increasing its quality under Bertrand competition, but by reducing its quality under Cournot competition. It follows that at the Nash equilibrium in qualities, firm H in the developed country overestimates the extent to which the quality gap will widen as it raises its quality in the Bertrand case, but underestimates the widening of the gap in the Cournot case. Since firm H gains from a widening of the quality gap under both forms of competition, it sets too high a quality in the Bertrand case (explaining the investment tax) and too low a quality (explaining the investment subsidy) in the Cournot case.
We also consider the possibility that both producing countries coordinate their policies so as to maximize joint profits at the expense of consumers in the third country. These joint policies correct for the fact that the Nash equilibrium qualities do not take into account effects on the rival’s profit. A coordinated strategy under Bertrand competition involves an increase in differentiation as a means of reducing price competition. Thus the LDC would tax its firm while the developed country would subsidize its firm. Under Cournot competition, since each firm gains from a move of its rival down the quality ladder (narrowing the quality gap for firm L and widening it for firm H), both governments tax quality.
This paper has focused on strategic trade theory as a motive for policies aimed at the quality of exports. It is not hard to find alternative motives for policies directed at improving the quality of low quality exports, such as an effort by a government to reduce externalities that may damage its “country of origin” brand reputation, or as a means of allowing “infant industries” to catch up with world market standards. However, in addition to providing a further explanation for such policies, strategic trade theory can also help explain less intuitively obvious policies, such as attempts by governments to subsidize quality improvement in industries which are already global leaders in quality (e.g. Finland in paper and Canada in newsprint). Strategic trade policy also suggests circumstances in which governments with low quality sectors might want to encourage producers to remain in that niche of production rather than improve their quality (as was the case with Korea’s “Northern Strategy”).