R&D Policy Competition with Process Innovation in a Multi-Product Duopoly

This paper considers a reciprocal dumping model which consists of two countries, each owning a multi-product firm which sells products to both countries. The firms choose the R&D investment portfolio for their products, and a government may subsidize or tax its domestic firm for the R&D investment. It is shown that a firm invests more in R&D for its core (non-core) product if products are sufficiently differentiated (similar) to each other. Moreover, if a firm invests more in its non-core product than its core product, it does that to an extent such that the non-core product becomes the core product after the R&D process. Policy competition results in a unilateral incentive of a subsidy, and the stable optimal policy is always a subsidy. When two governments harmonize their policies, it is optimal for them to set subsidies to zero. The optimal subsidy in a duopoly is higher than that in a monopoly if and only if two governments' policies are strategic substitutes.