The purpose of this paper is to analyze the effects of retaliation and lobbying on the profit-shifting argument for export subsidies. Trade policy is modeled as a multistage game. It is shown that by trading partners against domestic export subsidies with retaliation foreign countervailing duties will undercut the profit-shifting motivation of these domestic subsidies. As a result, export subsidies may not be the optimal trade policy for the domestic government.
Furthermore, facing the threat of foreign countervailing duties, the incentive for domestic firms to lobby for export subsidies will be attenuated. This is because the countervailing duties will lower the marginal benefit of the lobbying effort for the domestic firms. In addition, from the domestic point of view, lobbying could be considered an unproductive profit-seeking activity. So in this regard, foreign countervailing duties could have the function of lowering resource-wasting domestic lobby activities.
