Cost Effectiveness of R&D and Strategic Trade Policy

Abstract

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. ; We acknowledge support from Comunidad de Madrid under grant 06/0064/00 and Ministerio de Ciencia y Tecnología under grant BEC2002-03715. We thank Peter Neary and participants of the ETSG and EARIE conferences for comments on an earlier draft and an anonymous referee for useful suggestions. The opinions and analyses herein are the responsibility of the authors and, therefore, do not necessarily coincide with those of the Banco de España or the Eurosystem. ; Publicado