Trade Policy in the Presence of Technology Licensing

This paper reconsiders strategic trade policy when a high-cost and a low-cost firm belonging to different countries compete a la Cournot in a third country market and technology is transferable. Assuming technology is transferred via licensing, optimal trade policy is characterized. Apart from affecting product-market profits - which is standard in this literature - any subsidy or tax also affects the licensing decision and the surplus generated from licensing. Considering the effects of subsidy on profits, surplus and the subsidy bill, we find that both the governments would often opt for lower subsidy compared to the Brander-Spencer subsidy rate - the optimal subsidy rate in the absence of possibility of licensing. In fact, for a range of cost parameters, optimal policy for the government of the high-cost firm turns out to be a tax. Further, in contrast to the existing literature on strategic trade policy with asymmetric costs we find non-monotone relationship between optimal subsidy and cost-competitiveness of firms. In particular, we find that efficient firms might be taxed while relatively less efficient firms might be subsidized.