International competition, technological convergence, and innovation policy

Regarding the innovative activity in the US and the rest of the world, there are two strong observations: 1) There is a clear convergence in the number of patents (and also citations) issued by US and non-US based firms over the course of the 1970’s until the mid-1980’s.  2) In the first half of the 1980’s, R&D subsidies and tax credits were introduced both at the federal and state level in the US and a halt of the technological convergence followed. In this paper, we ask the following questions: What have the welfare consequences of the R&D policies of the 80’s been?Should the R&D policies of a country be geared towards the industries in which it is less (or more) competitive? We build a Schumpeterian endogenous growth model in which two countries compete over the leadership in different product lines to study international technology competition and to evaluate the effect of innovation policy. The novel feature of the model is that a firm’s R&D investment depends both on its technology gap with its foreign competitor, as well as on the technological level of its domestic sector in its country. The latter generates a positive externality of a firm’s innovative activity on others operating in the same country. In the absence of policy intervention, the model is able to replicate the convergence observed in the data. Innovation policies undo the inefficiencies caused by the uninternalized spillovers. Surprisingly, the model predicts that subsidizing already-advanced sectors in a country could be optimal since it discourages foreign followers by widening the gap even further and hence eliminating future competition.