Vertical integration and strategic trade policies

This paper examines the use of strategic trade policies, such as export subsidies, to encourage domestic production of an intermediate input and a final product in a model with international rivalry between firms in two countries. The choice of subsidies or taxes in several cases is examined. Whether subsidies are welfare-improving depends on whether firms are vertically integrated. We show that as long as firms in at least one country are vertically integrated, the optimal subsidy on final-good production is positive.