Strategic Investment Subsidies under Asymmetric Oligopoly

• DOI: http://doi.org/10.1111/rode.12098
• Published date: 01 August 2014
• Date: 01 August 2014
• Author: Naoto Jinji,Tsuyoshi Toshimitsu

Strategic Investment Subsidies under

Asymmetric Oligopoly

Naoto Jinji and Tsuyoshi Toshimitsu*

Abstract

This paper examines strategic investment subsidies in an international oligopoly. A general oligopoly

model is constructed in which firms compete in two stages and governments commit to investment subsidies

prior to firms’ actions. The paper considers asymmetry among firms that arises from the nature of goods

they produce rather than their cost structures. When firms produce asymmetrically differentiated goods, it

is found that a change in the number of foreign competitors may alter the sign of the optimal unilateral

investment subsidy. An example of policy reversal is provided in the case of strategic research and develop-

ment subsidies for a quality-differentiated industry.

1. Introduction

Responding to the global financial and economic crisis in 2008–2009, governments of

many countries implemented stimulus packages to encourage consumer demand and

support manufacturers in difficulty. Some efforts targeted specific industries; for

example, stimulus packages for the automobile industry reached US$17.4 billion in

the USA, €1.5 billion in Germany, and £2.3 billion in the UK (OECD, 2009).

Although the packages emphasized measures to stimulate purchases of new and

cleaner cars, support was also provided for “investments in green technology and

fuels to reduce energy consumption and carbon dioxide emissions” (OECD, 2009: 6).1

Governments’ incentives to provide investment subsidies to domestic industries are

not necessarily restricted to periods of economic crisis. In 2005, the European Com-

mission released an action plan for a comprehensive reform of state aid policy

(Commission of the European Communities, 2005). Although it proposed reducing

the general level of state aid, it also argued that the reduction must be accompanied

by a shift of aid toward objectives of “common interest,” putting a high priority on

research and development (R&D) and innovation.

Although the European Commission emphasizes the market failure associated with

R&D as a rationale for the state aid (Commission of the European Communities,

2005), the literature of strategic trade and industrial policies makes it clear that invest-

ment subsidies (such as R&D subsidies) can be used as a strategic trade policy (Leahy

and Neary, 2009). A well-known criticism in the strategic trade policy literature is,

however, that the specific policy prescriptions are highly sensitive to changes in the

* Jinji: Faculty of Economics, Kyoto University, Yoshida-honmachi, Sakyo-ku, Kyoto 606-8501, Japan. Tel

& Fax: +81-75-753-3511; E-mail: jinji@econ.kyoto-u.ac.jp. Toshimitsu: Kwansei Gakuin University,

Nishinomiya, 662-8501, Japan. The authors thank seminar participants at the 1st HITS-JT seminar on inter-

national economy and industry at Aomori Public College and an anonymous referee for helpful comments

and suggestions on earlier versions of the paper. Jinji acknowledges financial support from the Japan

Society for the Promotion of Science under the Grant-in-Aid for Scientific Research (B) No. 23330087. The

usual disclaimer applies.

Review of Development Economics, 18(3), 490–501, 2014

DOI:10.1111/rode.12098

© 2014 John Wiley & Sons Ltd