Export subsidies in an imperfectly competitive market when market share matters: The case of international wheat trade

Panu Kyosti Samuli Kallio, Purdue University

Abstract

A dynamic, game theoretic model with switching costs provides better understanding of motives that keep export subsidies a part of exporters' agricultural policies. Switching costs include factors, such as transactions costs and political considerations, that affect an importer's purchasing decisions. Effects of these costs are dynamic in nature, because switching costs vary with the level of earlier purchases. Behaviors of exporting countries and firms are not driven solely by maximization of current welfare and profits, but also by the desire to increase current market share, which could improve future welfare and profits. In our multi-period framework, exporting countries face a tradeoff between exploiting current market share with higher prices and lower export subsidies, or competing for larger market shares with lower prices and larger subsidies. In wheat export competition to Morocco, the EU and U.S. are noncooperatively behaving "super-powers" whose actions influence each other's agricultural policies and world prices. Subsidized exports of EU and U.S. wheat are sold abroad by large exporting firms who may also have market power. Econometric estimates of import demand functions suggest switching costs exist in the Moroccan market, and switching costs from U.S. wheat are larger than costs from EU wheat. Exporting firms charge lower prices and higher export subsidies are awarded by governments when switching costs are present. This suggests that costs of export promotion programs may be higher than is often expected. Investigation of alternative institutional arrangements (game structures) showed that unilateral elimination of export subsidies is the worst scenario for the country eliminating subsidies. Improvement of U.S. welfare in the free trade case explained its initial willingness to eliminate export subsidies under GATT. MacSharry CAP reform helped make GATT upper bounds for EU export subsidies more acceptable, consistent with the notion that it was an important element in reaching GATT agreement. Finally, results show that, while it is important for exporting countries to prevent formation of a firm cartel, some degree of firm level market power is welfare improving for exporters. Results also suggest that order of play has important implications for players' market power and so, strategic behavior.

Degree

Ph.D.

Advisors

Abbott, Purdue University.

Subject Area

Agricultural economics

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