Why do governments subsidize R&D-Intensive foreign direct investment?

Subsidizing research and development (R&D)-intensive foreign direct investments (FDI) of multinational enterprises (MNEs)—such as through the Creating Helpful Incentives to Produce Semiconductors and Science Act of 2022—is becoming increasingly prevalent worldwide. However, little is known about host governments' incentives for offering them and their strategic potential. Using a simple theoretical model, this study investigates the welfare consequences of an R&D-intensive FDI subsidy compared to those of three other widely used policy alternatives: (i) providing a subsidy based on the MNE's output, (ii) setting the level of intellectual property right enforcement, and (iii) mandating technology transfer through licensing. Our results demonstrate that when the domestic firm's absorptive capacity is sufficiently high, subsidizing MNEs' R&D efforts is welfare-superior to the three other policy alternatives, as it generates positive externalities for domestic firms. Additionally, MNEs' innovation outcomes, profitability, and global welfare can be maximized when an R&D subsidy is chosen. Thus, the findings have key implications for policymakers regarding the welfare consequences of such subsidy policies.