Vertical Differentiation, Uncertainty, Product R & D and Policy Instruments in a North-South Duopoly

This paper analyzes the impact of several trade policy instruments on product Research and Development (R & D) investment in a North-South duopoly where a Northern firm competes in prices with a Southern firm on both markets. The Northern firm invests in product R & D owing to a competitive disadvantage compared to its Southern counterpart which benefits from a lower labor cost. The outcome of the R & D activity is uncertain. If successful, vertical differentiation occurs in both markets. The Northern country?s government is the only one to be policy active and may implement the following policy instruments: an import tariff, an import quota or a quality standard. The results show that the Northern firm?s R & D expenditures increase with each policy instrument except for the import quota. The paper also dresses a comparative review of the effects of these measures based on a detailed welfare analysis. Numerical simulations suggest that in most cases, the Northern country?s government would favor the implementation of an import tariff, except for when the consumer preference for product quality is high. In that case, the favorite instrument would be the quality standard.