Detection and Impact of Industrial Subsidies: the Case of World Shipbuilding

Harvard University, Cambridge MA

Investigators

Abstract

Government subsidies to industries have been prevalent throughout economic history and in several countries have steered industrialization and growth. An important and open question is what is their impact on production allocation across countries, industry prices, costs and surplus. A significant challenge in this task is that government subsidies to industries are notoriously difficult to detect. Indeed, partly because WTO agreements prohibit direct and in-kind subsidies other than infrastructure, the existence and magnitude of such subsidies is often unknown. The proposed research offers two contributions to the effort of assessing the consequences of subsidies. First, it provides a model-based empirical strategy to detect the presence and gauge the magnitude of government subsidies. Second, it quantifies the impact of these subsidies on industrial evolution. The PI applies this strategy to the world shipbuilding industry, a prototypical example of an industry in which subsidies are believed to play a prominent role. Shipbuilding in the 2000's is a particularly interesting case because a striking reallocation of production took place: in a single year (2006), China doubled its market share from 25% to 50%, leaving Japan, S. Korea and Europe trailing behind. In 2006, China launched a capital subsidization plan; these capital subsidies are known, observed and not prohibited. However, many asserted that China's rapid rise was also driven by government production subsidies, which are not known, unobserved and prohibited; here the PI disentangles the contributing factors (e.g. differentiated products, inherent cost differences, and most importantly, capital and production subsidies). The proposal will develop and estimate a model of the shipbuilding industry, providing one of the first empirical analysis in industrial organization looking at dynamic agents on both the demand and the supply side. A large number of shipyards offer durable, differentiated ships. Their production decisions are subject to a dynamic feedback because of time to build: shipyards accumulate backlogs, which affect their future ability to accept new ship orders. Production is also subject to an aggregate stochastic cost shock, summarized in the price of steel, a key production input. Every period a large number of identical potential shipowners decide to enter the freight market by buying a new ship from world shipyards. Demand for new ships is driven by demand for international sea transport, which is uncertain and volatile. As ships are long-lived investments for shipowners, demand for new ships is dynamic. The model primitive of interest is the cost function of potentially subsidized firms. As in many industries, however, costs of production are not observed. The PI?s strategy amounts to estimating costs from demand variation, as is common in empirical industrial organization, but in a framework of dynamic demand and supply. The estimation strategy first uses new and used ship prices to estimate the willingness to pay for a new ship and then inserts it into the dynamic optimization problem of shipbuilders. The first objective of the empirical analysis is to detect and measure changes in costs that are consistent with subsidies. The second objective of the empirical analysis it to use the estimated model to quantify the impact of China's subsidies on ship prices, production reallocation across countries, as well as industry costs and shipper surplus. The PI asks the question whether this impact varies by different types of subsidies (capital or production subsidies).