R&D Subsidies International Knowledge Dispersionand Fully Endogenous Productivity Growth

This paper develops a two country model to investigate the effects of national R&Dsubsidies on aggregate product variety and endogenous productivity growth withoutscale effects. In particular, monopolistically competitive firms invest in process innovationwith the aim of lowering production costs. With imperfect knowledge dispersion,the larger of the two countries has a larger share of firms and a greater level ofproductivity. The higher concentration of relatively productive firms increases the sizeof knowledge flows between firms, leading to an increase in firm-level employment ininnovation. As a result, an economy with asymmetric countries produces a faster rateof growth than one with countries of similar size. The larger scale of firm-level innovationactivity reduces market entry, however, and overall product variety falls. Usingthis framework, we find that a national R&D subsidy has a positive effect on the industryshare, relative productivity, and wage rate of the implementing country. Moreover,if the smaller country introduces an R&D subsidy, overall product variety rises but therate of productivity growth falls. Alternatively, if the larger country introduces an R&Dsubsidy, the rate of productivity growth rises, but overall product variety may rise orfall. Finally, we briefly consider the effects of a national R&D subsidy on national andworld welfare levels.