Strategic Trade Policy, the 'Committed' Versus 'Non-Committed': Government and R&D Spillovers

Abstract

We compare the social welfare generated by a domestic government in the two types of policy setups: a commitment regime in which the government sets its policy instrument before the strategic choice is made by the domestic firm and a non-commitment regime where the policy variable is set after the strategic choice is made by the firm. The government conducts strategic trade policy in the form of optimal tariffs under which domestic and foreign firms compete in quantities in an imperfectly competitive domestic market where cost reducing R&D spillovers take place from the domestic to the foreign firm. We show that the non-committed government achieves generally a higher level of welfare and levies a lower optimal tariff than the committed government. Moreover, when the domestic government is allowed to use an R&D subsidy, that may or may not be accompanied by the optimal tariff, the resulting optimal subsidies are always positive.