Common Market with Regulated Firms

We examine the effect of bilateral trade in a concentrated industry under Cournot competition, when firms are regulated by national agencies who care about national social welfare. We allow for differences in costs and market sizes and for asymmetric information between regulatory agencies and regulated firms. A national regulatory policy may or may not be publicly observed by foreign competitors. We show that it is optimal to allow states to subsidize their domestic firms: bilateral trade improves the allocative efficiency and reduces the agency costs of regulation. Strategic trade policy effects that appear when regulatory contracts are public are beneficial to both states and reduce incentive costs as well as allocative inefficiencies. Results extend to the case of segmented markets with export costs when states are allowed to use export subsidies as well as to regulate domestic production. They also extend under perfect information to an arbitrary number of states and regulated firms, to the existence of private importing firms and of a not too large export market.