Optimal industrial policy in vertically related markets

Siu-Kee Wong and Yao Liu1

The Journal of International Trade & Economic Development, 2011, vol. 20, issue 5, 631-650

Abstract: This paper examines the optimal industrial policy for an industry with a vertical market structure. A home firm and a foreign firm both import an intermediate good from a third country to produce a final good. How the home country government sets the optimal industrial policy has to take account of both profit shifting between the two final good producers and between the intermediate good producer and the home firm. We explain how the optimal industrial policy depends on the slope of the demand curve, the levels of technology spillover and product differentiation. In particular, there exists a critical level of technology spillover at which investments of the firms are neither strategic substitutes nor complements and the optimal industrial policy is always investment tax.

Date: 2011
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DOI: 10.1080/09638190903150753

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