Government Subsidies of R&D in a Product Cycle Framework: US–Japan Simulations

The welfare effects of R&D subsidies are examined using a product cycle model of trade between two developed countries. Simulations are done for steady‐state welfare in Japan and the USA for high‐ and low‐skilled labor over different combinations of subsidy rates. Japanese subsidies to R&D usually benefit Americans owing to an increase in product variety. However, because Japanese R&D reduces wages in the US high‐tech sector, American high‐skilled workers are hurt if Japanese subsidies are too large. Large American subsidies may cause Japanese innovation to cease. However, Japanese steady‐state welfare would be maximized in this case.