Why do export subsidies still exist? R&D and output subsidies

Abstract

To analyze why export subsidies still exist, we demonstrate the endogenous choice of strategic variable (R&D subsidy or output subsidy) in the third-market model in which exporting firms perform the R&D investment. We find that even though each government can improve welfare when it chooses R&D subsidy policy simultaneously, choosing output subsidy policy for both exporting governments is dominant strategy regardless of the degree of R&D spillover effect. This leads both governments to face prisoners' dilemma. Thus, even though the subsidies may cause trade disputes since direct subsidies are prohibited under WTO, our paper can provide the reason why some countries have incentives to use output subsidy policy rather than using R&D subsidy policy. On equilibrium path, it follows that social welfare under government non-intervention (e.g. free trade) is higher than under output subsidy. Furthermore, whether to reach the Pareto-superior cooperative R&D equilibrium, we provide some discussions.