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Innovation Under The Threat Of Direct Foreign Investment

Listed author(s):
  • Soma Roy


    (Department of Economics, Dum Dum Motijheel College)

  • Rajat Acharyya


    (Department of Economics, Jadavpur University)

We examine the implication of direct and indirect foreign competition on domestic innovation decision. In most of the existing theoretical analyses the foreign firms are assumed to enter the domestic-country market as an exporter and thus are subject to a tariff duty imposed by the local government. We consider a broader setting where the foreign firm also has the option of setting up a production unit in the domestic country to supply output to the domestic country. This enables it to avoid the tariff that it faces due to export. Once we allow for such a strategy option for the foreign firm, competition becomes more direct and intense since tariffs no longer discount for the technological inferiority of home firms. We show that innovation by the home firm will be discouraged at high tariffs under the threat of DFI. Again at low tariff rates exports by the foreign firm make market competition more intense and reduce the incentive for innovation. Hence the home firm always (never) innovates at low (high) R&D cost whatever be the tariff rate. For intermediate R&D cost the home firm innovates if the foreign firm opts for exports.

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Article provided by Chung-Ang Unviersity, Department of Economics in its journal Journal Of Economic Development.

Volume (Year): 34 (2009)
Issue (Month): 1 (June)
Pages: 81-98

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Handle: RePEc:jed:journl:v:34:y:2009:i:1:p:81-98
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  1. Neven, D. & Siotis, G., 1996. "Technology sourcing and FDI in the EC: An empirical evaluation," International Journal of Industrial Organization, Elsevier, vol. 14(5), pages 543-560, July.
  2. Hubert, Florence & Pain, Nigel, 2001. "Inward Investment and Technical Progress in the United Kingdom Manufacturing Sector," Scottish Journal of Political Economy, Scottish Economic Society, vol. 48(2), pages 134-147, May.
  3. Bouet, Antoine, 2001. "Research and development, voluntary export restriction and tariffs," European Economic Review, Elsevier, vol. 45(2), pages 323-336, February.
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