Strategic R&D policies with spillovers and trade liberalisation

We examine the impact of trade liberalisation and R&D policies on exporting firms' incentive to innovate and social welfare. Key factors determining the government's optimal policy are the strength of R&D spillover effect and the toughness of firm competition. When domestic exporting firms only compete in an overseas market, the optimal policy might be to tax firms' R&D. Trade liberalisation in the overseas market induces a higher R&D tax rate. When the firms also conduct business in home market, the government should financially support firms' R&D. Trade liberalisation always increases firms' output sales, R&D investments, and social welfare. In an international context where there is competition between exporting firms located in different countries, while forming an international R&D joint venture ensures a symmetric outcome, further international cooperation may lead to an asymmetric equilibrium with only one firm being subsidised on its R&D investment.