Cost Effectiveness of R&D and Strategic Trade Policy

We analyze how the cost-effectiveness of R&D influences the incentives for governments to impose export subsidies. Governments first impose an export subsidy, or a tax. After observing export policy, firms invest in cost reducing R&D and subsequently compete in the market. Governments subsidize exports under Cournot competition. Under Bertrand competition and for linear demands and constant marginal costs, export subsidies are positive whenever R&D is sufficiently cost-effective at reducing marginal costs, and negative otherwise. The trade policy reversal found in models without endogenous sunk costs disappears if R&D is sufficiently cost-effective. Thus, output subsidies seem more robust than implied by the recent literature.