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International Competition in Vertically Differentiated Markets with Innovation and Imitation: Trade Policy versus Free Trade

Author

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  • Eugen Kovac
  • Kresimir Zigic
Abstract
The important characteristic of international competition between developed and less developed countries is vertical product differentiation, where firms' quality choices represent strategic decisions. Unlike the previous literature, we allow for a leadership in quality choice and the possibility of imitation and learning by the domestic firm. We compare both positive and normative aspects of this setup in the free trade and the strategic trade policy regime and show that the value of leadership may change dramatically when moving from free trade to trade policy. We also identify conditions under which trade policy can initiate the change in the quality ladders (known as quality reversal) and demonstrate that such a policy has a somewhat limited scope to achieve it. Thus, free trade can still be an optimal trade arrangement.

Suggested Citation

  • Eugen Kovac & Kresimir Zigic, 2007. "International Competition in Vertically Differentiated Markets with Innovation and Imitation: Trade Policy versus Free Trade," CERGE-EI Working Papers wp336, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    • Handle: RePEc:cer:papers:wp336
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    References listed on IDEAS

    as
    1. Neary, J Peter & Leahy, Dermot, 2000. "Strategic Trade and Industrial Policy towards Dynamic Oligopolies," Economic Journal, Royal Economic Society, vol. 110(463), pages 484-508, April.
    2. Motta, Massimo & Thisse, Jacques-Francois & Cabrales, Antonio, 1997. "On the Persistence of Leadership or Leapfrogging in International Trade," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(4), pages 809-824, November.
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    4. Staiger, Robert W., 1995. "International rules and institutions for trade policy," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 29, pages 1495-1551, Elsevier.
    5. Herguera, Inigo & Kujal, Praveen & Petrakis, Emmanuel, 2002. "Tariffs, quality reversals and exit in vertically differentiated industries," Journal of International Economics, Elsevier, vol. 58(2), pages 467-492, December.
    6. Alireza Naghavi, 2007. "Strategic Intellectual Property Rights Policy and North-South Technology Transfer," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 143(1), pages 55-78, April.
    7. Bhattacharjea, Aditya, 1995. "Strategic tariffs and endogenous market structures: Trade and industrial policies under imperfect competition," Journal of Development Economics, Elsevier, vol. 47(2), pages 287-312, August.
    8. Brander, James A., 1995. "Strategic trade policy," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 27, pages 1395-1455, Elsevier.
    9. Ulrich Lehmann-Grube, 1997. "Strategic Choice of Quality When Quality is Costly: The Persistence of the High-Quality Advantage," RAND Journal of Economics, The RAND Corporation, vol. 28(2), pages 372-384, Summer.
    10. Fershtman, Chaim, 1989. "Fixed rules and decision rules : Time consistency and subgame perfection," Economics Letters, Elsevier, vol. 30(3), pages 191-194, September.
    11. Peter K. Schott, 2004. "Across-Product Versus Within-Product Specialization in International Trade," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 119(2), pages 647-678.
    12. Thomas J. Prusa & Reiko Aoki, 1997. "Sequential vs. Simultaneous Choice With Endogenous Quality," Departmental Working Papers 199510, Rutgers University, Department of Economics.
    13. Hallak, Juan Carlos, 2006. "Product quality and the direction of trade," Journal of International Economics, Elsevier, vol. 68(1), pages 238-265, January.
    14. Moraga-Gonzalez, Jose Luis & Viaene, Jean-Marie, 2005. "Trade policy and quality leadership in transition economies," European Economic Review, Elsevier, vol. 49(2), pages 359-385, February.
    15. Federico Etro, 2004. "Innovation by leaders," Economic Journal, Royal Economic Society, vol. 114(495), pages 281-303, April.
    16. repec:bla:econom:v:64:y:1997:i:254:p:265-79 is not listed on IDEAS
    17. Michael Kunin & Kresimir Zigic, 2004. "Strategic Trade Policy and Vertical Product Differentiation: intra-industry trade between developed and developing countries," CERGE-EI Working Papers wp230, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    18. Aoki, Reiko & Prusa, Thomas J., 1997. "Sequential versus simultaneous choice with endogenous quality," International Journal of Industrial Organization, Elsevier, vol. 15(1), pages 103-121, February.
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    Citations

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    Cited by:

    1. Rajat Acharyya & María D.C. García-Alonso, 2012. "Parallel imports, drug innovation and international patent protection: A policy game," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 21(6), pages 865-894, November.
    2. Hodaka Morita & Xuan Nguyen, 2012. "FDI and Technology Spillovers under Vertical Product Di erentiation," Discussion Papers 2012-19, School of Economics, The University of New South Wales.
    3. Boone, Jan & Žigić, Krešimir, 2015. "Trade policy in markets with collusion: The case of North–South R&D spillovers," Research in Economics, Elsevier, vol. 69(2), pages 224-237.
    4. Fei Yu & Yanrui Wu & Jin Chen & Arie Lewin, 2022. "Technological Leapfrogging and Strategic Patent Policy," Economics Discussion / Working Papers 22-17, The University of Western Australia, Department of Economics.
    5. Rajat Acharyya & Maria D.C. Garcia-Alonso, 2009. "Weak IPR and Imitation in the South and International Exhaustion of Patent Rights in the North for Innovated Drugs: A Policy Game," Studies in Economics 0919, School of Economics, University of Kent.
    6. Fei Yu & Yanrui Wu & Jin Chen & Arie Y. Lewin, 2023. "Technological leapfrogging and country strategic patent policy," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 54(5), pages 887-909, July.

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    More about this item

    Keywords

    Vertical differentiation; free trade; strategic trade policy; quality rever-sal; leadership; imitation.;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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