Bilateralism is good: Trade blocs and strategic export subsidies

This paper considers the effect of exogenous trade bloc enlargement in a multi-country version of the Brander-Spencer export subsidy game. In the single-shot game, it is shown that trade bloc enlargement leads to a reduction in the Nash equilibrium export subsidies and thereby increases the welfare of the exporting countries. Although the welfare of the importing countries decreases, world welfare may increase if the export subsidies are financed by distortionary taxation. When the export subsidy game is infinitely repeated, it is shown that trade bloc enlargement reduces the critical discount factor making it easier to sustain free trade.