Trade policy with risky investment in quality

Consider a new export market in which firms can invest in quality but may fail to achieve quality. Quality of the export good, then, varies across firms, having endogenous (whether to invest) and exogenous (determined by nature) aspects. Previous works suggest that the market outcome and socially optimal policy depend on whether quality is exogenous or endogenous. It is shown that the previous differences are driven by the demand and cost parameterizations, not by the endogeneity of quality. Previous works also suggest subsidies to raise welfare. Subsidies are found to lower welfare while a tax may raise welfare. JEL Classification: F13, D82, D83.