Country Asymmetries, Endogenous Product Choice and the Speed of Trade Liberalization

We analyze the e ects of trade liberalization on rms' decisions and pro ts in a vertical product di erentiation model with countries which have di erent characteristics. Firms decide product speci cations at the beginning of the game, in which autarky is followed by trade liberalization (whose date is anticipated). Our analysis suggests that a rm located in a large (or rich) country is the likely market leader at the trade equilibrium. This outcome might be reversed if small country rms have a strong cost advantage, transport costs are negligible, or if the large country opens its market before the small one. This paper is a thoroughly revised version of a paper having the same title and appeared as CEPR Discussion Paper No. 1326 (February 1996), London. We have bene ted from comments made by participants in seminars at Universidad del Pa s Vasco (Bilbao), London Business School, IIES (Stockholm), Universitat Pompeu Fabra, ERWIT 1995 (Thessaloniki), London School of Economics and Oxford University, and especially by Raquel Fernandez, Elhanan Helpman, Henrik Horn, Jorge Padilla, Alasdair Smith, Konrad Stahl. We are particularly grateful to Jim Markusen for comments and discussions on a previous draft. Partial nancial support from the CEPR MIRAGE program (Motta) and the Spanish Ministry of Education through DGYCIT grant PB93-0398 (Cabrales) and PB94-0663 (Motta) are also gratefully acknowledged. Department of Economics, Universitat Pompeu Fabra, RamonTrias Fargas 25-27, E-08005 Barcelona (Spain)