Foreign Technology, Spillovers, and R & D Policy

The authors study the appropriate domestic R&D policy in an asymmetric duopoly with R&D rivalry and technological spillovers from the more advanced firm. A 'foreign' and a 'home' firm compete over two periods on R&D and output. Initial foreign R&D lowers the cost of home's subsequent R&D improvements. The optimal policy balances the strategic incentive to reduce initial foreign R&D with the spillover incentive to increase it. If discounted home profits increase (decrease) with higher initial foreign R&D--the spillover (strategic) effect dominates--a tax (subsidy) to first-period home R&D is appropriate. Copyright 1997 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.