Strategic competition and optimal parallel import policy. Working Paper

We examine the role of parallel import policy as an instrument of strategic trade policy. We consider a duopolistic framework where the home firm enjoys uncontested monopoly power in its domestic market and has the option of serving the foreign market by incurring a fixed investment cost which is observed by the foreign firm prior to price setting. When price competition abroad is intense, the parallel import policy of (only) the home country affects the firm’s decision to export as well as its ability to price discriminate internationally. Interestingly, when the foreign market is significantly larger than the domestic one, the home firm gains if it is unable to price discriminate internationally; in an environment where arbitrage induced parallel imports can flow into the home country, the home firm’s desire to not deviate too far from its optimal monopoly price in the domestic market makes it (credibly) less aggressive in price competition abroad, and this softening of price competition raises profits. On the other hand, when the foreign market is not significantly bigger, it is optimal for the home country to forbid parallel imports since international price discrimination yields higher profits to the home firm. We show that the home country’s equilibrium parallel import policy is always pro-trade (i.e. it induces the home firm to export); it is also socially optimal provided that the fixed costs of exporting are not too large. When price competition is weak, the importing country’s policy determines the market outcome and its unique equilibrium choice is to permit parallel imports. Such openness to parallel imports turns out to be anti-trade and often in conflict with social welfare considerations