In Discussion Paper No. 1199, Research Affiliate Dermot Leahy and Research Fellow Peter Neary examine the theoretical implications for strategic trade and industrial policy of different assumptions about the timing of firm and government decisions, and the ability of agents to commit to future actions. They address the issue of jointly optimal strategic export and R&D subsidies by studying five different cases of two-period models in which a home and a foreign firm compete on a third market: the `Full' and the `Government-Only' Commitment Equilibrium; the Unanticipated and the Anticipated Government-Reneging Equilibrium; and lastly, the Sequence Equilibrium where agents behave optimally in correctly anticipating that no agent can commit to future actions.

For each of the five cases, the levels of home output, R&D subsidies and domestic welfare are estimated and compared. The main findings are as follows. The level of domestic welfare is higher when the government's commitment is credible, than when no agent can make credible commitments. Welfare is higher when the government's decision to renege is not anticipated by the private sector, than when the government does not renege at all. When government reneging is anticipated, the level of domestic welfare is very low. In particular, it is shown that unanticipated reneging only yields small welfare gains while anticipated reneging incurs large welfare losses. Overall, it is concluded that welfare is highest in the event of unanticipated, and lowest with anticipated reneging.

International R&D Rivalry and Industrial Strategy without Government Commitment
Dermot Leahy and J Peter Neary

Discussion Paper No. 1199, June 1995 (IT)