Cost Effectiveness of R&D and Strategic Trade Policy

Abstract

This paper analyzes the incentives for governments to impose export subsidies when firms invest in a cost saving technology before market competition. 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, 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.