Welfare Implications of Upstream Subsidy, Countervailing Duties, and Limited Verifiability

Based on a simple model integrating political contribution provided by exporting firms and verifiability problem of export subsidy for the upstream firms within intricately fragmented production processes, this paper demonstrates that strategic export policies influenced by political contribution can deteriorate social welfare. Moreover, when it is more difficult to identify the government subsidy provided to upstream firms within complicated vertical value chains, there is larger distortion due to higher export subsidies manipulated by the political contribution. Therefore, even if countervailing duties are imposed against the export subsidies, when the probability to detect the export subsidy is lower, the export subsidy dominates the countervailing duty with the distortion due to political contribution aggravated by the lower detection probability. These results implicate that with the deepening fragmentation of global production networks, as it gets more difficult to verify the subsidy provided to upstream production processes, it is more likely that the indirect and hidden strategic government interventions can be made. Therefore, it is imperative to make further efforts to enhance the verifiability of the hidden subsidies to reduce welfare deterioration caused by the politically manipulated strategic trade policies.