The Impact of the Covid-19 Fear on International Trade

Abstract

We present a partial equilibrium model of trade between two countries, domestic and foreign, with one firm in each country, producing a homogeneous good in a segmented market with reciprocal dumping. Both countries establish a cooperative and non-cooperative subsidy for their firms. The emergence of a fear shock in the home country, given by the Covid-19 pandemic, changes the market equilibrium. The results show that with non-cooperative policies, governments establish a subsidy to their firms. However, the country with higher market share sets a higher subsidy. With a fear shock, welfare is reduced in both countries and the domestic government responds by reducing the subsidy. With the cooperative policy, a uniform subsidy is set. When the fear shock reduces welfare in both countries, the optimal response is to increase the subsidy, otherwise the agreement breaks down.