The Choice of Trade Policy in an International Differentiated Duopoly with Process R&D Investment under Uncertainty

Abstract

Purpose - The purpose of this paper is to investigate equilibrium pairs of modes of government intervention in an international differentiated duopoly with process R&D investment under uncertainty. Governments in each of the two countries choose direct R&D investment and quantity controls, or R&D subsidies to shift profits towards domestic firms. Design/Methodology/Approach - For the analysis, we extend the model of Haaland and Kind (2008) to that with uncertainty and consider direct R&D investment and quantity controls besides R&D subsidies. Firms in each of the two countries produce differentiated products and governments in each compete via direct R&D investment and quantity controls, or R&D subsidies in a third-country market. In environments with low, high, and intermediate uncertainty, equilibrium pairs of modes of government intervention are examined. Findings - It is shown that (i) in an environment with low uncertainty, direct R&D investment and quantity controls by each government is a unique equilibrium if the goods are substitutes and not too close, and R&D subsidies by each government is a unique equilibrium if the goods are complements and not too close; (ii) in an environment with high uncertainty, R&D subsidies by each government is a unique equilibrium regardless of the nature of the goods, except in the cases of too close substitutes and complements; and (iii) in an environment with intermediate uncertainty, R&D subsidies by each government is a unique equilibrium if the goods are complements and not too close. Moreover, in an environment with intermediate uncertainty, there are two symmetric equilibria if the goods are substitutes and not too close and there are two asymmetric equilibria if the goods are substitutes and very close. Research Implications - By analyzing the effects of direct R&D investment and quantity controls, and R&D subsidies in international markets under uncertainty, we can expect which government intervention appears in equilibrium.