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Trade Liberalization and Optimal R&D Policies with Process Innovation

  • Thanh Le
  • Cuong Le Van

We set up a theoretical framework to discuss the impact of trade liberalization and R&D policies on domestic exporting firms' incentive to innovate and social welfare. In this framework, exporting firms invest in R&D to reduce their production costs and, in return, receive R&D subsidies from the government. While firms target at maximizing their profits, the government aims to maximize the social welfare. We consider different settings of firm competition to explore their strategic behaviours as well as the government's strategic behaviour at the policy stage. We find that tradeliberalization in the foreign market is always welfare enhancing and, in most cases, leads to higher export sales and R&D investments of firms, and raises productivity at firms and industry level. When firms are independent monopolies in the overseas market, it is optimal for the government not to provide any R&D subsidy. When goods are close substitutes, the social optimum can be achieved as a Nash equilibrium by applying an optimal R&D tax. Trade liberalization induces a higher R&D tax rate to be levied on firms. When firms also conduct business in the home market, it is always optimal for the government to provide firms with a financial support to their R&D activity. While this R&D subsidy is decreasing in the trade cost when firms are independent monopolies, its monotonicity in the trade costs is determined by the convexity of the R&D cost function when firms produce close substitutes.

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Paper provided by Department of Research, Ipag Business School in its series Working Papers with number 2014-119.

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Length: 23 pages
Date of creation: 25 Feb 2014
Date of revision:
Handle: RePEc:ipg:wpaper:2014-119
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  1. J.P. Neary & P O''Sullivan, 1998. "Beat Em or Join Em: Export Subsidies versus International Research Joint Ventures in Oligopolistic Markets," CEP Discussion Papers dp0408, Centre for Economic Performance, LSE.
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  8. Paula Bustos, 2009. "Trade Liberalization, Exports and Technology Upgrading: Evidence on the Impact of MERCOSUR on Argentinean Firms," 2009 Meeting Papers 1029, Society for Economic Dynamics.
  9. Alla Lileeva & Daniel Trefler, 2010. "Improved Access to Foreign Markets Raises Plant-Level Productivity... for Some Plants," The Quarterly Journal of Economics, MIT Press, vol. 125(3), pages 1051-1099, August.
  10. Kyle Bagwell & Robert W. Staiger, 1989. "The Sensitivity of Strategic and Corrective R&D Policy in Oligopolistic Industries," Discussion Papers 869, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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  12. Haaland, Jan I. & Kind, Hans Jarle, 2008. "R&D policies, trade and process innovation," Journal of International Economics, Elsevier, vol. 74(1), pages 170-187, January.
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