Time-Consistent Protection of an Infant- Industry: The Symmetric Oligopoly Case

This paper discusses the design of an optimal, time-consistent tariff to protect an infant-industry in the presence of learning effects. Firms decide how much to produce, taking into account learning effects induced by their current production and the tariff policy, while the government decides on the level of tariff protection. In order to ensure time consistency we solve the symmetric case without spillovers where learning leads to lower fixed costs. Assuming that domestic and foreign products are imperfect substitutes for each other but perfect substitutes within each group, we use a complete linear demand system to represent domestic consumers' preferences. The analytic Markov Perfect Equilibria of this game is derived by solving a linear-quadratic differential game. It is shown that in equilibrium, only a declining tariff over time can be regarded as a time-consistent tariff policy.