Abstract
We model a small open economy with an infant industry facing competition from imports. We derive the welfare maximizing output path and knowledge path for an infant industry under the central planner who can dictate the industry output. We next show how the social planner’s optimal path can be achieved when the infant industry is in private hand, focusing on two cases: the case where the infant industry consists of a monopoly and the case where it is a duopoly. In the case of a monopoly we show that free trade can induce the monopoly to choose the socially optimal production path. Contrary to conventional wisdom, we show that the volume of imports is large when the stock of knowledge is small, and gradually declines as this stock grows. In the case of a duopoly with knowledge spillovers we derive a family of subsidy rules capable of inducing a Markov perfect Nash equilibrium that replicates the social optimum. When the subsidy rule is linear affine in the state variable, we show that the subsidy rate per unit of output must be an increasing function of the stock. The underlying intuition is that the government should put domestic firms under a tough competition in their infancy with a promise to make their life easier as their knowledge grows.
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Notes
In their models, the state variable is the “sticky price” that adjusts slowly over time.
Many economists are not convinced that government intervention can always improve welfare in the presence of moral hazard or adverse selection. See, for example, Dixit [10].
In this paper, the domestic industry’s market structure is exogenous. We will separately consider the monopoly and duopoly cases. For the case of learning with an endogenous market structure see Dasgupta and Stiglitz [8].
We thank J. Peter Neary for the pun. He pointed out that our results indicate that there is a parallel between our result for infant industries and the educational experience of “industrious infants.” Typically, children that turned out to be genius were very much pushed by their parents. For example, Frank Gehry acknowledged that his mother would push him when he was a child [25].
In India, the computer hardware industry is in its infancy and supplies only the domestic market.
To grasp a first understanding of the nature of the trade-offs involved, in Sect. 3 we will conduct a preliminary analysis of the choice problem, under a very special assumption: The social discount rate is zero. Then, in Sect. 4, we will return to the main model, where the social discount rate is strictly positive.
We thank an anonymous referee for this clarification.
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Acknowledgements
We would like to thank Georges Zaccour (the handling editor of this paper) and two anonymous reviewers for their helpful suggestions. We are grateful to Murray C. Kemp and J. Peter Neary for their comments on an earlier version of this paper. Both authors thank the Social Sciences and Humanity Research Council of Canada (SSHRC) and Quebec’s funding agency FRQSC for financial supports.
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Appendix
Appendix
Proof of Corollary 2.2
From (24) we have:
For this to hold for all K we must have
or
From the proof of Corollary 2.1, we have established (34) that is \( \frac{1}{2Z}<\delta \) and therefore \(\rho +\delta -\frac{1}{2Z}>0\).
Since \(\sigma >0\) and we are focusing on the case where the regulator wishes to build a domestic industry, we have \(\phi ^{so}\left( 0\right) >0.\) We establish below that \(\psi (0)>0\). Using (29), we have
and we obtain after simplification
Now, given assumptions A1–A5, and given that we have assumed \(\left( p^{*}-c-\gamma \overline{K}\right) >0\), we argue that
Indeed, after simple substitution of Z from (30) inequality (A.2) becomes
which holds iff
or after simplification
This last inequality is in turn satisfied iff
or after simplification
which holds from Assumption A5. Therefore
and
This complete the proof of Corollary 2.2. \(\square \)
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Benchekroun, H., Van Long, N. Nurturing an Infant Industry by Markovian Subsidy Schemes. Dyn Games Appl 8, 519–541 (2018). https://doi.org/10.1007/s13235-018-0258-6
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DOI: https://doi.org/10.1007/s13235-018-0258-6