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Answers to Textbook Problems
1. The main disadvantage is that it can lead to both “rent-seeking” and beggar-thy-neighbor policies,
which can increase one country’s welfare at the other country’s expense. Such policies can lead to a
2. If everyone knows that an industry will grow rapidly, private markets will funnel resources into the
3. The results of basic research may be appropriated by a wider range of firms and industries than
the results of research applied to specific industrial applications. The benefits to the United States
4. A subsidy is effective when the firm in the other country does not produce when the domestic firm
enters the market. As the text tables show, a subsidy may present a credible threat of entry and deter
5. One argument you could make is the infant industry argument. Because U.S. software firms are already
established, European firms would not be able to compete given the relatively steep learning curve
in this industry. With protection, the European industry could develop into an efficient scale and
Another line of reasoning in favor of protection is that this industry needs support because of low
appropriability. If the social gains from an investment exceed the private gains, then a firm making
an investment will not be able to capture the full return on its investment and an inefficiently low
level of investment will be made. To get over this market failure, the government could subsidize
innovation. However, can the government accurately identify the right activities to support?
Furthermore, how big will the gains from active targeting be?
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley
Chapter 12 Controversies in Trade Policy 58
Finally, support could be justified if there is imperfect competition and excess profits in the
software industry. A subsidy to the European software industry may yield gains in excess of the
subsidy if European firms are able to capture some of the profits of American firms. However,
can the government correctly identify who and how much to subsidize? What if this policy leads
to retaliation by the American government?
6. The main critique against the WTO with respect to environmental issues is that the WTO refuses to
impose environmental standards on countries, but rather does not allow countries to discriminate
against imported goods that are held to a different standard than domestically produced goods. In
7. The French may be following an active nationalist cultural policy as an economic or strategic trade
policy to the extent that cultural activities, such as art, music, fashion, and cuisine, are linked to other
French major industries. Indeed, the fashion industry is tied to the huge textile industry, as well as to
8. The concern is seen clearly in the idea of the environmental Kuznets curve where environmental
damage increases as a country moves from very poor to middle income and declines as the country
gets subsequently richer. The problem comes if the fastest growing countries are the ones moving
from poor to middle income, especially large countries such as India and China who are almost
9. Suppose that there were no tariffs on imports in a country that had value-added taxes. This would give
an incentive for domestic firms to locate their production abroad and export their goods to that country
to avoid the value-added tax. Thus, a tariff on imports is necessary to maintain the same relative
price between domestically produced and imported goods. Similarly, the carbon tariff is put into place
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley
