Strategic Technology Investments in Open Economies

We study a general equilibrium model of international trade with heterogeneous firms, where countries can strategically invest in technology. The countries' motive is to improve firms' productivity, leading to a competitive advantage in international trade. We are interested in how trade liberalization affects this governmental incentive to invest in technology. In the closed economy countries invest if consumers have a sufficiently high preference for varieties. In the open economy we analyze the Nash-equilibrium policy and the cooperative policy. If there are no cross-country investment spillovers, countries strategically compete in their investment levels and increase their investments with higher trade openness. From a social perspective we have an overinvestment problem. If there are cross-country investment spillovers, we differentiate between weak and strong spillovers. In both cases the cooperative solution predicts a positive relationship between investments and trade openness. If there are weak (strong) spillovers, we find a positive (hump-shaped) relationship between technology investments and trade openness in the Nash-equilibrium. From a social perspective we obtain an over (under)-investment problem if spillovers are weak (strong).