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 dif-ferences in costs and market sizes, and for asymmetric information between regulatory agencies and regulated firms. A national regulat-ory 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 ex-tend to the case of segmented markets with export costs when states are allowed to use export subsidies as well as to regulate domestic production. ∗We thank David Martimort for very helpful discussions. †CREST-Laboratoire d’Economie Industriell