International Competition for R&D Investment

Two jurisdictions compete to attract shares of the R&D investment budget of a large multinational enterprise, whose investments potentially confer positive spillovers on national firms. The firm has private information both about its efficiency and about spillovers. It is shown that strategic tax competition may lead to overinvestments relative to the first-best allocation, that the excessive investments occur in the country where the positive spillover effects are lowest, and that they are most severe for the least efficient firms. This occurs for sufficently asymmetric spillovers, and implies that investments under competition are then excessively spread out and not properly concentrated to the country where spillovers would be largest.