Trade Policies for Intermediate Goods under International Interdependence

Transcription

1 Journal of Economcs and Management, 06, Vol., No., 7-49 Trade Polces for Intermedate Goods under Internatonal Interdependence Chun-Hung Chen * Department of Accountng, Chaoyang Unversty of Technology, Tawan Ths study nvestgates nternatonal trade polcy wth ntermedate goods belongng to the nternatonal dvson of labor. The man conclusons are as follows. Frst, f the governments of two producng countres must choose whether to ntervene wth ths trade, they can select trade polces and abandon fnal goods by adoptng polces taxng ntermedate goods. Second, the governments of the two producng countres can cooperate to ncrease welfare. Ths cooperaton agreement vews the sum of ntermedate and fnal goods trade polces n the ndvdual countres as a net subsdy. In ths agreement, ntermedate and fnal goods trade polces have dsplacement. Thrd, when the market structure of ntermedate goods of a certan producng country s transformed from an ntal monopoly to perfect competton, ths country s government uses taxaton polces for trade n fnal goods. The government of the other country mplements subsdzaton polces for trade n ntermedate and fnal goods. Keywords: export subsdy, export tax, ntermedate goods, fnal goods JEL classfcaton: F3, F5 Receved August 30, 05, frst revson January 9, 06, second revson March 6, 06, accepted March 4, 06. * Correspondence to: Department of Accountng, Chaoyang Unversty of Technology. No.68, Jfeng E. Rd., Wufeng Dstrct, Tachung County 4349, Tawan. Tel: , E-mal: shhchng@cyut.edu.tw. The author gratefully acknowledges the fnancal support of the Natonal Scence Councl, Tawan, under grant no. NSC H-34-0.

2 8 Journal of Economcs and Management Introducton Ths study examnes the equlbrum of governments adoptng optmal trade polces wth fully complementary ntermedate goods nternatonally from the perspectve of the nternatonal dvson of labor, by whch s meant that trade takes place based on the comparatve advantage of producton, rather than the operaton of the labor market. We fnd that ntermedate goods play an ncreasngly crucal role, wth numerous factors nfluencng the trade n ntermedate goods. Among these factors, nterdependent relatonshps among ntermedate goods nternatonally are especally apparent. In the future, ths phenomenon wll be an mportant topc n nternatonal trade theory. In nternatonal trade theory, the majorty of studes on trade polcy ssues wth ntermedate goods have begun from the perspectve of cost advantages or sngle ntermedate goods suppler countres. The cost advantage perspectve assumes that the ntermedate goods produced by each country are homogeneous, although one of these countres has an advantage n that t enjoys lower costs. The companes n ths country can then sell ther ntermedate goods at lower prces. Ths s equvalent to one country supplyng ntermedate goods alone. For example, Spencer and Jones (99, 99 showed that the optmal trade polces of a country wth cost advantages vary wth fnal good competton patterns. The perspectve of countres wth supplers of sngle ntermedate goods allows only a certan country to monopolze the producton of ntermedate goods. For example, Chang and Km (989 showed that the optmal tradng polcy for supplers of ntermedate goods s to adopt free trade polces. The other countres can then tax the fnal goods. In recent years, models wth complementary elements have gradually receved much attenton from academa, because the trend toward economc cooperaton s ncreasng, and ths n turn has replaced the vertcal ntegraton wthn a sngle frm or country n the past, as ponted out, for example, n Matsushma and Mzuno In optmal trade polces for countres wth cost advantages, the fnal goods market s characterzed by Cournot quantty competton and Bertrand prce competton. In these stuatons, the drectons (taxng or subsdzng taken n polces for ntermedate and fnal goods are consstent and opposng, respectvely.

3 Trade Polces for Intermedate Goods under Internatonal Interdependence 9 (0, Matsushma and Mzuno (03, Resnger and Tarantno (03, and Heckng and Panke (04. A revew of the trade polcy lterature shows that the complementary relatonshps among ntermedate goods are not apparent. However, t s common for ntermedate goods to be fully complementary nternatonally. In the real economc world, due to the comparatve advantage whch has led to specalzed producton, each country must be specalzed n ts producton. However, each country also needs the help of other countres that provde ntermedate goods n a complementary way to produce the fnal goods, and so trade n complementary ntermedate goods wll always occur. One example relates to the numerous domestc computer companes that have engaged n nternatonal cooperaton. In addton to creatng ther own brands, these companes have mutually produced components for foregn brands. However, conventonal studes typcally assume that ntermedate goods are a type of nternatonal competton. They have been unable to fully descrbe ths condton n economc theory. Ths study therefore seeks to determne whether governments use ntermedate good trade polces to replace the trade polces for fnal goods when ntermedate goods are fully complementary nternatonally, thereby reducng the mportance of fnal goods n trade polces. Early models of complementary ntermedate goods were bult on compatblty theory. For example, Matutes and Regbeau (988 and Economdes (989 examned whether companes adopt compatble (entrely complementary strateges wth compettors for ntermedate goods, and found that companes do select compatble strateges. Matutes and Regbeau (988 found that for all values of the reservaton prce ( C and the degree of horzontal product dfferentaton between the two frms products (, both frms equlbrum profts are hgher when frms sell compatble components than when they sell ncompatble ones, where the consumer s surplus s calculated based on the reservaton prce mnus the sum of the prce of the system and the cost of horzontal product dfferentaton. Economdes (989 found that under Assumptons Al, A, and A3, frms make hgher profts under compatblty, A s the cross-partal dervatve of the transportaton cost functon and s non-postve, A s the demand for consumers resdng at any pont n the space and s downward slopng and weakly concave, and A3 s the demand

4 30 Journal of Economcs and Management and s relatvely nelastc. The condtons of these two papers are not surprsng, but under these assumptons, frms that adopt compatble polces wll be superor to those that adopt ncompatble polces. In these two papers, the choce of compatblty or ncompatblty nvolves comparatve statc analyss, but n our model t s assumed that compatblty (complementarty s an optmal exogenous polcy, and s therefore not consdered to be an ncompatble phenomenon. Ths study s based on the phenomenon that companes typcally use compatblty for a game model. We have used ths model to dscuss the nteractve relatonshps n terms of decson-makng among governments n the trade of ntermedate and fnal goods when ntermedate goods are entrely complementary nternatonally. Ths study focuses on two topcs. Frst, we analyze the nfluence on nternatonal trade polcy n relaton to ntermedate goods that are entrely complementary nternatonally. When ntermedate goods are n the nternatonal dvson of labor, the drecton n the trade polcy adopted by the government and whether ths drecton changes the concluson n the conventonal lterature that governments unversally rely on the trade polcy of fnal goods are examned. Second, ths study analyzes the nfluence of changes n the market structure of ntermedate goods of a certan country on the optmal trade polcy when ntermedate goods are entrely complementary nternatonally. Ths study also examnes how a government s trade polcy responds n each country when the market structure of the ntermedate goods of a certan country s transformed from an ntal monopoly to perfect competton. To acheve these goals, we frst establsh a model wth two markets of ntermedate goods monopolzed by two countres and a market duopoly of fnal goods. We use ths model to dscuss the Nash equlbrum created by the governments of countres that adopt optmal trade polces when the ntermedate Economdes (989 n hs Fg. ponted to the compatblty ssue of montor desgn and computer desgn. In ths example, the relatvely nelastc demand assumpton n A3 s not the prce elastcty of demand, It refers to the followng assumpton nd ( n ( D D, where D D s the effect on demand of frm of an equal prce ncrease by all frms. In other words, t measures the loss of consumers ntally located wthn the market area of a frm to outsde goods. D s the change n the demand when the opponent ncreases ts prce, and DD 0, D 0. n s the number of systems. We calculate ths assumpton to obtan the followng condton D/ D [ n / ( n ]. In fact, we have found that ths assumpton s not too strong.

5 Trade Polces for Intermedate Goods under Internatonal Interdependence 3 goods produced by the two countres are entrely complementary. We establsh a model wth two countres cooperatng to seek cooperaton contracts for trade polces. We change a porton of the market structure of ntermedate goods to examne how governments formulate optmal trade polces when the ntermedate goods market of one of the countres s characterzed by perfect competton. Ths study s organzed as follows. Followng ths secton s ntroducton, n Secton we establsh a basc model wth four companes n three countres. In Secton 3, we analyze the balance of governments adoptng optmal trade polces when ntermedate goods are fully complementary nternatonally and the ntermedate goods manufacturers of each company are all monopoles. In Secton 4, we analyze the trade polces establshed by the governments of two countres engagng n cooperaton. In Secton 5, we change the ntermedate goods market n a certan country to perfect competton to examne the nfluence of the market structure of ntermedate goods on trade polces. Secton 6 s ths study s concluson. Basc Model Fgure presents the model used n ths study. We establsh a heterogeneous product model wth four companes n three countres. Ths model has four sets of partcpants: the governments of Countres and, the vendors of ntermedate goods of Countres and (upstream ndustres, the manufacturers of fnal goods of Countres and (downstream ndustres, and the consumers of Country 3. Countres and are producng countres, whereas Country 3 s a consumng country. The governments of the two producng countres decde optmal export trade polces. These two countres each have one ntermedate goods manufacturer and one fnal goods manufacturer. The ntermedate goods manufacturers each monopolze the producton of a crucal ntermedate good. The fnal goods manufacturers must purchase a unt of the ntermedate good from the two ntermedate goods manufacturers to produce one unt of the fnal good. The fnal goods manufacturers n these two countres sell the fnal goods produced to the thrd

6 3 Journal of Economcs and Management country. 3 The two fnal goods are heterogeneous products. Fgure : The Internatonal Trade Structure of Intermedate Goods under Interdependence Ths model s mplemented n three stages. In the frst stage, the governments of the two producng countres consder whether to ntervene wth exports of the fnal and ntermedate goods or to adopt lassez-fare strateges. The two governments have four decsons n regard to exports: ( ntervene n both ntermedate and fnal goods; ( ntervene n ntermedate goods, whle adoptng lassez-fare for fnal goods; (3 adopt lassez-fare for ntermedate goods, whle ntervenng n fnal goods; and (4 adopt lassez-fare for both ntermedate and fnal goods. Ths nterventon refers to the government addng quantty taxes or subsdes to exports. The export tax that government decdes to levy on ntermedate goods s s. The export tax that government decdes to levy on fnal goods s t. 4 Because the producng country s welfare s the sum of the upstream and downstream vendors profts and the government s taxes, the objectve functon of government 3 The conventonal lterature also typcally assumes that the consumers of the producng country do not consume the fnal goods, whch are sold only to the thrd country as n Brander and Spencer ( If the varables s and t are postve, ths ndcates taxaton. Negatve values ndcate subsdzaton.

7 Trade Polces for Intermedate Goods under Internatonal Interdependence 33 s as follows. W ( s, s, t, t s q t q. ( j In ths equaton, manufacturers, and q ( represents the proft of country s ntermedate goods represents the proft of country s fnal goods manufacturers, q represents consumers demand for country s (j s fnal goods j (, j,, j. In the second stage, the ntermedate goods manufacturers of the two countres monopolze the producton of ntermedate goods and set prce a for ther own profts. To smplfy the analyss, assume that the producton cost of the ntermedate goods manufacturers s 0. Although there s no cost dfference nternatonally, t needs to be asked what are the reasons for the dvson of labor between countres. In actual fact, snce only a complementary relatonshp exsts, t then consttutes a dvson of labor economcs, wthout the need for nternatonal dfferences n cost. Because the demand for the two ntermedate goods manufacturers products s the demand derved from the downstream ndustres, the proft functon of country s ntermedate goods manufacturers s as shown n Equaton (. The frm n country sells the ntermedate goods to the foregn country at the same prce (.e., a, where ( a s q means that the net proft from the exports s equal to the revenue aq j j mnus taxaton sq. j a q ( a s q. ( j In the thrd stage, the two countres fnal goods manufacturers combne equal proportons of the two ntermedate goods nto fnal goods. Each unt of the ntermedate goods can form one unt of the fnal goods. In the thrd stage, the fnal goods manufacturers engage n prce competton n the thrd country, settng the prce at p for ther personal proft. To smplfy the analyss, assume that the assembly cost for the fnal goods manufacturers s 0. Thus, only the costs of purchasng ntermedate goods are faced. The proft functon of country s fnal goods manufacturers s as follows: ( p t q ( a a q. (3 j Regardng the demand for the fnal goods n the thrd consumng country, the

8 34 Journal of Economcs and Management two countres fnal goods are set as heterogeneous products. Ths results n the demand functon for country s fnal goods beng expressed as follows: q p p. (4 j In ths equaton,,, 0. The relatonshp between the parameters and represents the degree of substtutablty between the two countres fnal products. If 0, ths ndcates that the two products are stand-alone products. If, ths ndcates that the two products are entrely substtutes for each other. We assume that. Therefore, the two fnal goods have a certan degree of heterogenety. The product dfferentaton s crucal for the results obtaned n the paper, because we assume that, whch rules out entrely the substtute stuaton. In the analyss below, although there are several cases derved n ths paper, as shown n Appendces A and B, snce the present model does not assume that the sze of s greater or smaller than and, due to the assumptons, we do not assume the real values of these three varables, and therefore many varables cannot be compared. We wll focus on the comparatve trade polces, and thereby deduce four propostons. 3 Optmal Trade Polcy Ths study s model nvolves a three-stage game used to obtan a subgame perfect equlbrum. Backward nducton from the fnal stage should be used to obtan optmal trade polces for the two countres governments. In the thrd stage, country s fnal goods manufacturers determne fnal goods prces to maxmze ther own profts. Usng the two manufacturers frst-order condtons smultaneously, we can solve the fnal goods prce as a functon of ntermedate goods prces and tax rates. t t ( ( a a j p. (5 4 - In the second stage, country s ntermedate goods manufacturers determne ntermedate goods prces to maxmze ther own profts. Usng these two manufacturers frst-order condtons smultaneously ndcates that ntermedate

9 Trade Polces for Intermedate Goods under Internatonal Interdependence 35 goods prces are a functon of tax rates. s s j t t a. (6 3( 6 6 In the frst stage, government chooses whether to ntervene wth ntermedate and fnal goods or to adopt lassez-fare polces. If the government decdes to ntervene, tax or subsdzaton rates must be determned to maxmze the country s welfare. Therefore, pror to solvng the Nash equlbrum entrely, 6 stuatons can be classfed. Ths s because the two countres governments can decde whether to ntervene wth the trade n ntermedate and fnal goods or to adopt lassez-fare polces. Therefore, each government has four strateges. 5 Under these 6 condtons, the governments select optmal trade polces to pursue ther own greatest welfare W. However, pror to the Nash equlbrum, we must understand whether a consstent drecton exsts n the two governments decsons to tax or subsdze n these 6 stuatons. The answer we have obtaned for ths queston s affrmatve. The trade polcy selectons of the two countres n these 6 stuatons and ther welfare are shown n the Appendces. Therefore, we arrve at Proposton : [Proposton ] The drectons n tradng polcy adopted by the two countres governments n the 6 combnatons produced when the governments decde whether to ntervene wth ntermedate and fnal goods exports or to adopt lassezfare polces all conform to the followng consstency: taxng or adoptng lassezfare polces for ntermedate goods ( s 0 and subsdzng or adoptng lassezfare polces for fnal goods ( t 0. 6 Equaton (6 ndcates that a government taxng ntermedate goods and subsdzng fnal goods ncreases the prce of ths country s ntermedate goods. Because the ntermedate goods are not competng wth each other, but have a complementary relatonshp, the government does not have to use subsdes to ncrease the compettveness of ntermedate goods. The government taxes 5 The four export polces are ( ntervene wth both ntermedate and fnal goods; ( ntervene wth ntermedate goods, and adopt lassez-fare for fnal goods; (3 adopt lassez-fare for ntermedate goods, and ntervene wth fnal goods; and (4 adopt lassez-fare for both ntermedate and fnal goods. 6 There are 6 cases n Table A-, Table A-, Table A-3 and Table A-4. In addton to the frst case of Table A- beng an nternal soluton of trade polcy, the other 5 cases are exogenous corner solutons.

10 36 Journal of Economcs and Management ntermedate goods nstead. Although ths measure ncreases the unt costs of the country s fnal goods manufacturers, t also ncreases the unt costs for the opposng country s fnal goods manufacturers. The negatve nfluence of ths on the country s fnal goods manufacturers s comparatvely moderate, 7 and far smaller than the benefts of the prce ncrease that accrue to the ntermedate goods manufacturers. 8 In addton, the government s goal n subsdzng fnal goods s to create a cost advantage for the country s fnal goods, thereby helpng strengthen market competton n the thrd country, and expandng ther market n the thrd country. 9 Ths concluson s dentcal to that of Brander and Spencer (985 n the conventonal lterature, who nvestgated only fnal goods polces. In the frst stage, we found that the two countres were both characterzed by stable Nash equlbra n the 6 polcy combnatons at the dsposal of the two governments as they chose whether to ntervene n the ntermedate and fnal goods trade. The followng proposton can be derved: [Proposton ] When the ntermedate goods of two countres are entrely complementary and the fnal goods are heterogeneous products, the two governments optmal tradng polcy s to adopt net taxaton for ntermedate goods ( s * 0 0 and lassez-fare for fnal goods ( t * 0. Ths proposton shows that when the nternatonal dvson of labor s ncreasngly prevalent, the mportance of an ntermedate goods trade polcy may exceed that of the fnal goods trade polcy. Ths concept dscards the conventonal thnkng that the subsdzaton of fnal goods s used to ncrease compettve strength. Ths s replaced wth ntermedate goods taxaton to mprove welfare. The 7 / s ( [4 ( s s( t(4 8 t j(4 4 ]/[8( ( ]. 8 / s [ 8 4 ( s s( t(7 4 t j( 7 ]/[8( ( ]. 9 The nfluence of the government s polces on the demand for fnal goods s q / t (8 4 (4 6 0, If t 0, then t s a tax; on the other hand, f t 0, then t s a subsdy. q / t 0 means that subsdzng fnal goods can expand the market n the thrd country. 0 The optmal trade polcy s s / [( (8 3 ]. *

11 Trade Polces for Intermedate Goods under Internatonal Interdependence 37 prmary reason for ths transformaton n trade polcy s the complementarty of ntermedate goods and the roles of decson-makng and welfare. However, ths equlbrum s not optmal for the two countres. If the two countres change ther polces to subsdze only fnal goods, ths s benefcal to both countres. Ths Pareto-mproved soluton s, however, not an equlbrum soluton. Ths s because both governments have ncentves to tax ntermedate goods. 3 Even f the two countres add addtonal taxes to ntermedate goods, ths wll stll not result n an equlbrum. Ths stuaton s smlar to the prsoner s dlemma. 4 Cooperaton Agreement between the Two Governments Currently, regonal economc ntegraton and economc communtes are becomng ncreasngly prevalent. Varous natons wth close relatonshps n lfe or producton frequently draw up cooperaton agreements on trade ssues. In ths secton, the two orgnally self-nterested tradng natons coordnate to facltate ther common nterests. Followng Secton, the jont welfare of the two countres can be wrtten as follows: W( s, s, t, t W ( s, s, t, t W ( s, s, t, t p q p q. (7 The manufacturers decson problems durng the second and thrd stages are dentcal to those of Secton. All manufacturers are determnng prces to maxmze personal proft. Durng the frst stage, the two governments determne s, t, s, and t for maxmum jont welfare. We can then obtan the followng proposton: [Proposton 3] When the two governments focus on seekng maxmum jont In ths equlbrum, the welfare of the two countres s (7 3 /[(8 3 ( ]. At ths tme, the two countres can subsdze only fnal goods. Ther welfare s as follows: (4 ( /[( ( ]. 3 In the orgnal equlbrum, f one country betrays the equlbrum and adds addtonal taxes to ntermedate goods, the welfare of the betrayng country wll ncrease as follows: ( /[( ( ] 0. The result obtaned n the above s because

12 38 Journal of Economcs and Management welfare, they formulate the followng trade polcy: the fnal goods trade polces of the two countres are dentcal. All ntermedate and fnal goods polcy varables are mutually nterchangeable and the total effect s subsdzaton. The varables can be expressed as follows: t t and s s t t (4 3 / [ ( ] 0. 4 Ths proposton shows that when the two countres jontly establsh optmal trade polces, all ntermedate and fnal goods trade polces are entrely mutually replaceable. Regardless of how these four trade polces are swtched, upstream and downstream vendor profts, the two countres total welfare, and fnal goods prces are not affected. 5 Ths shows that the two governments do not requre excuses to subsdze or levy taxes as long as subsdzatons are focused on a certan country s fnal goods or ntermedate goods trade polcy. However, ths cooperatve soluton s unstable. The two governments have ncentves to adopt net taxaton. 6 Agreements must be establshed for enforcement. Even wth mandatory enforcement on farness prncples, an agreement must eventually be reached: s s, t t, and s t (4 3 / [ ( ]. We obtan s t 0, whch refers to net subsdzaton under an agreement. Gven that welfare s maxmzed wthout nterventon n theory, why should s t not be equal to 0? Ths s because the two countres are both export-orented. However, f one country s export-orented and the other s mport-orented, the optmal trade polcy under the agreement s the free trade polcy (.e., s t 0. 5 Intermedate Goods Market Wth a Monopoly and Competton Coexstng 4 Although nternatonal cooperaton n producton can lead to one country producng the ntermedate goods wth the other producng the fnal goods n other models, there does not necessarly need to be complementary producton between the two countres, snce a sngle country alone can ntegrate ntermedate goods and fnal goods n the vertcal ntegraton of producton. 5 The upstream manufacturers profts are / (4. The downstream manufacturers profts are ( /[ ( ]. The two countres total welfare s /[( ]. The fnal goods prce s /[( ]. 6 At ths tme, Country s welfare W (5 3 / [4 ( ] ( s t / s a monotoncally ncreasng functon of s t.

13 Trade Polces for Intermedate Goods under Internatonal Interdependence 39 Suppose that one of the producng countres opens ts ntermedate goods market to perfect competton. The government s trade polcy s to no longer ntervene n ths market. The other country s ntermedate goods market, by contrast, remans a monopoly. Ths secton examnes how the optmal trade polces of the two producng countres change when ther ntermedate goods are n ths type of asymmetrc market structure. When Country s ntermedate goods are n perfect competton and trade polcy no longer ntervenes, then a 0 and s 0. Wth ths excepton, the other structures are all dentcal to the basc model n Secton. By usng reverse nducton n the frst stage, the fnal goods manufacturers establsh fnal prces to maxmze ther own profts (Equaton (3. The optmal equlbrum prce s shown n Equaton (5. The results of ths response functon are brought back to the second stage. The ntermedate goods manufacturers set fnal prces to maxmze ther own profts (Equaton (. We can obtan Country s optmal ntermedate goods prce as follows: s t t a. (8 ( 4 4 Equatons (5 and (8 wth optmzed condtons are brought back to the frst stage to examne whether the two governments adopt trade polces n pursut of ther own welfare (Equaton (. Ths topc s subgame perfect equlbrum can be nferred. Thus, we put forward the followng proposton: [Proposton 4] If the two ntermedate goods market structures change, Country s remans a monopoly and Country s changes to perfect competton. Therefore, the two governments have the followng optmal export trade polcy: Country s government adopts subsdzaton trade polces for ntermedate and fnal goods ( s 0 and t 0, and Country leves taxes on the fnal goods trade ( t 0. When Country s ntermedate goods market s transformed from a monopoly to perfect competton, Country s optmal polcy s to adopt subsdzaton and not taxaton for ntermedate goods. The government of Country s optmal polcy s to tax fnal goods and not to adopt lassez-fare or subsdzaton polces. Ths result conflcts wth those of prevous studes and even the conventonal lterature. We

14 40 Journal of Economcs and Management reflect further on ths result. We frst address the ntermedate goods trade polcy. In the model n Secton 3, the two countres market structures are symmetrcal. In addton, the prcng of the ntermedate goods s strategcally replaceable. 7 Therefore, f Country s government adopts subsdzaton strateges for ntermedate goods, Country s ntermedate goods prces wll be reduced and Country s ntermedate goods prces wll ncrease. 8 However, Country s ntermedate goods market s now characterzed by perfect competton. The two ntermedate goods no longer nteract n terms of prce. 9 Equatons (, (, and (3 show that the welfare of Country s government s [ W ( s, s, t, t sq tq [ aq ( a s q ( p t q ( a a q ] sq tq ( p a q aq. Therefore, the nference from the dfferences n the models descrbed shows that the subsdzaton polces produce greater unfavorable factors n the former model. Therefore, Country s government has more (less of an ncentve to subsdze (tax n the latter model (e.g., the frst case n Table B- n the appendx: s [ ( ( ] ] /[ (4 5 ] 0 than n the former model (e.g., the frst case n Table A- n the appendx: s [ ( ] /[(8 3 ( ] 0. Ths study examnes the fnal goods trade polcy. In the model n Secton 3, the two countres are symmetrcal n terms of ther market structure. If Country s government adopts taxaton polces on fnal goods, then the costs faced by the fnal goods manufacturers ncrease, whch rases fnal goods prces. Ths reduces the demand for fnal goods and also decreases the derved demand for ntermedate goods. Country s ntermedate goods market s now characterzed by perfect competton. However, taxaton polcy can nfluence only the demand for fnal goods. It does not nfluence the profts of ntermedate goods manufacturers. Therefore, Country s government has more (less of an ncentve to tax (subsdze n the latter model (e.g., the frst case n Table B- n the appendx: t [ ( ] /[ (4 5 ] 0 than n the former model (e.g., the frst case n Table A- n the appendx: t /[8 3 ] When the fnal goods manufacturers engage n prce competton, / aa ( / ( 0. 8 Equaton (6 shows that da/ ds / 3 and da / ds / 6. 9 a 0 s known. Equaton (8 shows that da / ds / 4. j

15 Trade Polces for Intermedate Goods under Internatonal Interdependence 4 6 Concluson Ths study nvestgates optmal trade polces where ntermedate goods are characterzed by an nternatonal dvson of labor. When examnng trade polces, prevous studes faled to consder ntermedate goods n the nternatonal dvson of labor. Because ths s a common phenomenon, we analyzed the nfluence of nternatonally nterdependent ntermedate goods on the overall trade strategy. In addton, we also nvestgated the nfluence of changes n the market structure of the ntermedate goods on the optmal trade polcy. We establshed a model wth two ntermedate goods monopolzed by upstream manufacturers n two countres wth olgopolstc fnal goods market structures. Ths model was used to nvestgate the nfluence of the nternatonal dvson of labor on the two governments trade polces when the ntermedate goods are entrely complementary nternatonally and the fnal goods markets are characterzed by mperfect competton. Ths study frst used the lnear demand functon n whch the upstream and downstream market structures of the producng countres are symmetrcal, and the ntermedate goods manufacturer costs are standardzed to 0. We obtaned the followng prelmnary man results. Frst, when ntermedate goods manufacturers from two countres monopolze two ntermedate goods and the two countres governments must frst choose whether to ntervene n the trade n ntermedate and fnal goods, the two governments wll abandon fnal goods trade polces n equlbrum. Instead, they wll adopt taxaton trade polces on only ntermedate goods. Second, n addton to the government s optmal strategy beng to tax ntermedate goods, f the two governments engage n levyng addtonal taxes on the fnal goods, then the welfare of the two countres wll ncrease. Ths s not at the equlbrum pont, but f the two governments can formulate a contract, t can ncrease the welfare of both partes. We found that ths contract adopts net subsdzaton on the sum of ntermedate and fnal goods trade polces. Fnally, by changng the orgnally symmetrcal ntermedate goods market structure of one country to a structure wth perfect competton, we found that that country s optmal trade polcy for fnal goods s to tax. The other country s optmal trade polcy for ntermedate and fnal goods s to subsdze.

16 4 Journal of Economcs and Management Appendx A. Decson Makng and Welfare of Two Countres n Intermedate and Fnal Goods Trade Polcy Country \ Country Interventon n ntermedate and fnal goods Interventon only n fnal goods Interventon only n ntermedate goods No nterventon n ntermedate or fnal goods s s t t W ( (8 3 ( 8 3 Table A- Interventon n ntermedate and fnal goods (7 3 W ( ( ( ( s ( ( ( t (8 6 4 t ( ( ( W ( ( ( W s ( (8 3 (3 (4 s ( (8 3 (3 ( t 4 3 (0 W ( (8 3 (3 W (6 4 3 ( (8 3 (3 4 s ( (0 ( t 3 0 (3 W ( (0 (0 4 ( (0 3 3 W

17 Trade Polces for Intermedate Goods under Internatonal Interdependence 43 Table A- Country \ Country Interventon n ntermedate and fnal goods Interventon only n fnal goods Interventon only n ntermedate goods No nterventon n ntermedate or fnal goods Interventon only n fnal goods 3 3 ( ( s ( ( (8 6 4 t ( t ( ( ( W ( ( ( W (4 3 t (4 3 t ( ( ( W 3 3 ( ( ( W ( s ( ( ( (4 3 t W W ( ( ( ( ( ( ( ( ( (4 3 t W 3 3 ( ( ( ( ( ( W

18 44 Journal of Economcs and Management Table A-3 Country \ Country Interventon n ntermedate and fnal goods Interventon only n fnal goods Interventon only n ntermedate goods No nterventon n ntermedate or fnal goods (4 s ( (8 3 (3 8 s ( (8 3 (3 ( t 4 3 W (6 4 3 ( (8 3 (3 (0 W ( (8 3 (3 Interventon only n ntermedate goods ( s ( ( ( ( t W W ( ( ( ( ( ( s ( (8 3 s ( (8 3 (7 3 W ( (8 3 (7 3 W ( (8 3 s ( (7 3 W (5 3 W (7 3 ( ( (

19 Trade Polces for Intermedate Goods under Internatonal Interdependence 45 Country \ Country Interventon n ntermedate and fnal goods Interventon only n fnal goods Table A-4 No nterventon n ntermedate or fnal goods 4 s ( (0 ( t W (0 4 ( (0 (3 W ( (0 ( (4 3 t Interventon only n ntermedate goods s ( (7 3 No nterventon n ntermedate or fnal goods ( ( ( W W 3 3 ( ( ( (5 3 W (7 3 ( W (5 3 W 9( ( (5 3 W 9( (

20 46 Journal of Economcs and Management B. Decson Makng and Welfare of Two Countres n the Intermedate and Fnal Goods Trade Polcy When the Second Country s Intermedate Goods Market s n Perfect Competton and Government Trade Polcy Does Not Intervene Country \ Country Interventon n fnal goods Table B- ( ( s ( (6 5 3 t Interventon n ntermedate and fnal goods (4 5 (4 5 ( No nterventon n ( fnal goods s 4 t ( ( ( W ( ( W ( t 4 W (3 8 ( W 6

21 Trade Polces for Intermedate Goods under Internatonal Interdependence 47 Table B- Country \ Country Interventon n fnal goods No nterventon n ntermedate or fnal goods Interventon n only fnal goods ( t (6 0 5 ( ( ( t (6 0 5 ( (6 3 ( W (6 0 5 ( (6 3 (0 (8 3 W (6 0 5 (0 3 4 ( (6 3 t W W 3 3 ( ( (44 5 ( ( (44 5 Table B-3 Country \ Country Interventon n fnal goods No nterventon n ntermedate or fnal goods 3 3 ( s Interventon only n ntermedate goods ( 5 ( 5 ( ( t ( ( ( W ( (6 3 (0 3 W ( ( 5 s 3 W ( (3 W (3

22 48 Journal of Economcs and Management Table B-4 Country \ Country Interventon n fnal goods No nterventon n ntermedate or fnal goods 3 3 (4 t No nterventon n ntermedate or fnal goods (6 3 ( W W ( ( (6 3 (0 ( (6 3 (0 (5 3 W 4( ( W 4( References Brander, J. A. and B. J. Spencer, (985, Export Subsdes and Internatonal Market Share Rvalry, Journal of Internatonal Economcs, 8, Chang, W. W. and J. C. Km, (989, Competton n Qualty-dfferentated Products and Optmal Trade Polcy, Keo Economc Studes, 6, -7. Economdes, N., (989, Desrablty of Compatblty n the Absence of Network Externaltes, The Amercan Economc Revew, 79, Heckng, H. and T. Panke, (04, Quantty-settng Olgopoles n Complementary Input Markets - The Case of Iron Ore and Cokng Coal, Techncal Report, Energewrtschaftlches Insttut an der Unverstaet zu Koeln. Matsushma, N. and T. Mzuno, (0, Proft-enhancng Compettve Pressure n Vertcally Related Industres, Journal of the Japanese and Internatonal Economes, 6, 4-5. Matsushma, N. and T. Mzuno, (03, Vertcal Separaton as a Defense aganst Strong Supplers, European Journal of Operatonal Research, 8, Matutes, C. and P. Regbeau, (988, Mx and Match : Product Compatblty wthout Network Externaltes, RAND Journal of Economcs, 9, -34. Resnger, M. and E. Tarantno, (03, Vertcal Integraton wth Complementary Inputs, TILEC Dscusson Paper No , SSRN elbrary. Spencer, B. J. and R. W. Jones, (99, Vertcal Foreclosure and Internatonal Trade

23 Trade Polces for Intermedate Goods under Internatonal Interdependence 49 Polcy, The Revew of Economc Studes, 58, Spencer, B. J. and R. W. Jones, (99, Trade and Protecton n Vertcally Related Markets, Journal of Internatonal Economcs, 3, 3-55.