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ERC WORKING PAPERS

The Myth of Profit-Shifting Trade Policies

Onur A. Koska and Frank Stähler

Abstract:
Since Dixit (1984), it is well accepted that a home country's best policy is to ban imports in an oligopolistic market if the resulting monopoly has a cost advantage over imports. This note (i) provides a formal proof and (ii) extends this result to symmetric firms. When domestic instruments are available, the optimal policy in a non-cooperative game is to subsidize local production such that it completely replaces imports. This policy is also globally first-best.

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