Dynamic Effects of Subsidies on Output and R&D in an International Export Rivalry Model

Abstract

Why do governments often subsidize research and development (R&D) activities undertaken by domestic firms that compete with foreign firms in international markets? To answer this question, Spencer and Brander (1983) have examined a multistage subgame-perfect equilibrium model of international duopoly in which the first-stage (subsidy) game is played by the governments of two producing countries while the subsequent-stage (R&D and output) games are played by duopoly firms, each belonging to one of the two countries. They have shown that if the objective of each government is to maximize domestic welfare, it has an incentive to subsidize R&D activities of the domestic firm unless export subsidization is a feasible commercial policy for each government. They have also shown that subsidizing domestic R&D activities contributes to the rise in domestic welfare through the capture of a greater share of the output by the domestic firm.¹