Public policies in open economies

PUBLIC POLICIES IN OPEN ECONOMIES BY VU THANH HAI %6RF6FL+RQV DQG06RF6FL186 A THESIS SUBMITTED FOR THE DEGREE OF DOCTOR OF PHILOSOPHY IN ECONOMICS DEPARTMENT OF ECONOMICS NATIONAL UNIVERSITY OF SINGAPORE 2013 DECLARATION I hereby declare that the thesis is my original work and it has been written by me in its entirety. I have duly acknowledged all the sources of information which have been used in the thesis. This thesis has also not been submitted for any degree in any university previously. ___________________ Vu Thanh Hai 28 March 2014 Contents R&D subsidies in open symmetric economies 1.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.1 Overview . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.2 Household . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.3 Production and Market . . . . . . . . . . . . . . . . . 12 1.2.4 Innovation . . . . . . . . . . . . . . . . . . . . . . . . . 14 1.2.5 R&D and incentive . . . . . . . . . . . . . . . . . . . . 14 1.2.6 Government Budget . . . . . . . . . . . . . . . . . . . 17 1.2.7 Labour markets . . . . . . . . . . . . . . . . . . . . . . 17 1.3 Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 1.4 Special case . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 1.5 Nash equilibrium and social optimization . . . . . . . . . . . 27 1.5.1 Nash equilibrium . . . . . . . . . . . . . . . . . . . . . 27 1.5.2 Social optimum . . . . . . . . . . . . . . . . . . . . . . 30 1.6 Numerical results and economic policy . . . . . . . . . . . . . 31 1.7 R&D subsidy in global trade liberalization . . . . . . . . . . . 40 1.8 Conclusion 40 . . . . . . . . . . . . . . . . . . . . . . . . . . . . Standardization and patent policies in North-South economies 46 2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 2.2 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 2.2.1 Households . . . . . . . . . . . . . . . . . . . . . . . . 52 2.2.2 Product markets . . . . . . . . . . . . . . . . . . . . . 53 2.2.3 Innovation and standardization . . . . . . . . . . . . . 54 2.2.4 No-arbitrage condition . . . . . . . . . . . . . . . . . . 56 Steady-state equilibrium . . . . . . . . . . . . . . . . . . . . . 60 2.3.1 Monopolistic price setting . . . . . . . . . . . . . . . . 61 2.4 Uniform patent for …rst case . . . . . . . . . . . . . . . . . . . 83 2.5 Equilibrium results for the other two cases . . . . . . . . . . . 88 2.5.1 89 2.3 Monopoly-pricing . . . . . . . . . . . . . . . . . . . . . 2.6 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 2.7 Appendix A . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 2.8 Appendix B . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 2.9 Appendix C . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 2.9.1 Limit pricing under …rst case . . . . . . . . . . . . . . 115 2.9.2 Second case under limit pricing regime . . . . . . . . . 119 2.9.3 Welfares of second case under limit-pricing regime . . 120 2.9.4 Third case under limit-pricing regime . . . . . . . . . 120 2.9.5 Welfares of third case under limit-pricing regime . . . 121 Branch innovations and reverse spill-over with R&D subsidies 124 3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124 3.2 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130 3.2.1 Households . . . . . . . . . . . . . . . . . . . . . . . . 131 3.3 3.4 3.5 3.2.2 Product markets . . . . . . . . . . . . . . . . . . . . . 135 3.2.3 Innovations: Base and branch . . . . . . . . . . . . . . 136 Steady-state equilibrium . . . . . . . . . . . . . . . . . . . . . 140 3.3.1 Welfare . . . . . . . . . . . . . . . . . . . . . . . . . . 145 3.3.2 Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 148 Skilled and unskilled labour . . . . . . . . . . . . . . . . . . . 159 3.4.1 Welfare . . . . . . . . . . . . . . . . . . . . . . . . . . 187 3.4.2 Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 188 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199 List of Tables 1.1 Case i . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 1.2 Case ii . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 1.3 Case iii . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 1.4 Case iv . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 1.5 Case v . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 1.6 Case vi . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 2.1 Case i with e¤ects of di¤erent patent lengths . . . . . . . . . 81 2.2 Case i with parameters’sensitivity analysis . . . . . . . . . . 84 2.3 Case i with e¤ects of di¤erent uniform patent lengths . . . . . 87 2.4 Case ii with e¤ects of di¤erent patent lengths . . . . . . . . . 122 2.5 Case iii with e¤ects of di¤erent patent lengths . . . . . . . . . 123 3.1 Sensitivity analysis under homogenous labour setting . . . . . 152 3.2 E¤ect of economy U’s subsidy under homogenous labour setting155 3.3 E¤ect of economy J’s subsidy under homogenous labour setting157 3.4 E¤ect of economy U’s subsidy under homogenous labour setting with higher RSE . . . . . . . . . . . . . . . . . . . . . . . 158 3.5 E¤ect of economy J’s subsidy under homogenous labour setting with higher RSE . . . . . . . . . . . . . . . . . . . . . . . 158 3.6 Sensitivity analysis under two-labour setting . . . . . . . . . . 191 3.7 E¤ect of economy U’s subsidy under two-labour setting . . . 194 3.8 E¤ect of economy J’s subsidy under two-labour setting . . . . 195 3.9 E¤ect of economy U’s subsidy under two-labour setting with higher RSE . . . . . . . . . . . . . . . . . . . . . . . . . . . . 196 3.10 E¤ect of economy J’s subsidy under two-labour setting with higher RSE . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197 List of Figures 1.1 Welfare of economy as subsidy rates vary. Parameters: aLn1 = 30; aLx1 = 0:4; aLn2 = 18; aLx2 = 0:3; L1 = 3; L2 = 1; = 0:7; 1.2 = 0:035 . . . . . . . . . . . . . . . . . . . . . . . . 33 Welfare of economy as subsidy rates vary. Parameters: aLn1 = 30; aLx1 = 0:4; aLn2 = 18; aLx2 = 0:3; L1 = 3; L2 = 1; = 0:7; 1.3 = 0:035 . . . . . . . . . . . . . . . . . . . . . . . . Total welfare as the subsidy rate vary. Parameters: aLn1 = 30; aLx1 = 0:4; aLn2 = 18; aLx2 = 0:3; L1 = 3; L2 = 1; = 0:7; = 0:035 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.4 34 35 Response functions of the two economies. Parameters: aLn1 = 30; aLx1 = 0:4; aLn2 = 18; aLx2 = 0:3; L1 = 3; L2 = 1; = 0:7; = 0:035 . . . . . . . . . . . . . . . . . . . . . . . . 36 2.1 Labour-clearing condition graphs of Case . . . . . . . . . . 75 2.2 Welfare of the North in Case 1. Parameters: bS = 0:3; bN = 1; = 0:3; aS = 18; aN = 14; LS = 1:2; LN = . . . . . . . . . 2.3 88 Welfare of the South in Case 1. Parameters: bS = 0:3; bN = 1; = 0:3; aS = 18; aN = 14; LS = 1:2; LN = . . . . . . . . . 89 2.4 Labour-clearing condition graphs of Case . . . . . . . . . . 108 2.5 Labour-clearing condition graphs of Case . . . . . . . . . . 114 3.1 Welfare of economy U under homogenous-labour case. Parameters: LU = 1, LJ = 1:2; aU = 5; aJ = 2; bU = 1; bJ = 0:3; = 0:035; 3.2 = 1, = 0:3: . . . . . . . . . . . . . . . . . . . . 156 Welfare of economy J under homogenous-labour case. Parameters: LU = 1, LJ = 1:2; aU = 5; aJ = 2; bU = 1; bJ = 0:3; = 0:035; 3.3 = 1, = 0:3: . . . . . . . . . . . . . . . . . . . . 156 Welfare of economy U under two-labour case. Parameters: HU = 0:5, HJ = 0:5; LU = 0:5; LJ = 0:5; aU = 5; aJ = 2; bU = 1; bJ = 0:3; 3.4 = 0:035; = 0:6, = 0:7 . . . . . . . . . . 198 Welfare of economy J under two-labour case. Parameters: HU = 0:5, HJ = 0:5; LU = 0:5; LJ = 0:5; aU = 5; aJ = 2; bU = 1; bJ = 0:3; = 0:035; = 0:6, = 0:7 . . . . . . . . . . 198 Acknowledgement I am very grateful to my supervisor, Zeng Jinli, for being patient and understanding in his guidance throughout the progress of this thesis. Indeed, I really appreciate the amount of time that he invested in from listening and discussing the ideas to reading my drafts to give advice. I would like to thank Professors who are in the committee, attended my seminars and gave advice for the development of my thesis: Aamir R. Hashmi, Ho Kong Weng, Lee Soo Ann, Liu Haoming, Lu Yi, Shandre M. Thangavelu, Tomoo Kikuchi, Zhang Jie and Zhu Shenghao. I also enjoyed the friendships forged in this programme with Lai Yoke, Tong, Jingping, Jack and many others in the two PhD rooms. Your friendships helped me out of the stress. To the National University of Singapore, thank you for the opportunity that I can learn in conducive environment from the Professors - both in and outside departments, teach, and in turn learn from the students. To the sta¤s of Economics department, I really appreciate your service and your helps to all the administrative works; I, too, enjoyed talking to some. Thank you Mom, Dad and my elder sister’s family for encouraging me to further my study. I hope this is a pleasant gift to you. Thanks to my church friends and pastors for praying for me and encouraging me. And above all, I thank God for His faithfulness and blessings throughout the journey. 191 aJ = aU = Parameters = 0:35 = 0:4 aU = aU = aJ = aJ = HU = 0:4 HU = 0:6 HJ = 0:4 HJ = 0:6 LU = 0:4 LU = 0:6 LJ = 0:4 LJ = 0:6 = 0:03 = 0:04 = 0:55 = 0:65 = 0:5 = 0:6 = 0:3 = 0:6 g (%) Benchmark 8.85 Alternative 8.23 7.59 11.10 7.329 9.151 8.638 7.022 10.652 8.736 8.938 8.85 8.85 8.85 8.85 8.952 8.748 9.064 8.643 9.351 9.837 Benchmark HJ = 0:5 LU = 0:5 (%) parameters 18.40 parameters 17.119 15.778 18.681 18.117 36.887 12.243 18.046 18.634 14.704 22.094 18.40 18.40 18.40 18.40 18.611 18.185 18.843 17.968 18.472 18.537 LJ = 0:5 HU = 0:5 J’s Welfare results 155.759 results 108.388 74.256 194.906 129.640 168.358 146.219 122.942 122.942 148.440 161.447 154.7505 156.592 154.229 157.018 216.493 116.836 160.643 151.087 164.435 172.877 = 0:035 = 0:3 U’s Welfare 163.614 115.682 80.988 204.232 136.434 172.790 156.897 128.367 128.367 158.914 167.303 161.840 165.072 162.849 164.247 225.657 123.709 168.498 158.942 172.627 181.391 Table 3.6: Sensitivity analysis under two-labour setting 192 Table 3.7 records how the two economies would behave if we …x zJ at 0.00 and increase zU . Growth rate, g; would increase because more …rms can enter the R&D sector due to the subsidy. What we notice from the numerical results is that there is one optimal zU for economy U (at zU = 0:83): The optimal zU for economy J is 0.91. Meanwhile, the value of zU that gives highest welfare of both economies combined is 0.87. As such there is a con‡ict of interest between the two economies, economy J would prefer economy U to have a higher subsidy rate than the preference of economy U itself. To understand why there is an optimal subsidy rate zU for economy U , we refer back to the previous part with homogenous labour. There are two e¤ects working in opposite direction as zU increases. First, as zU increases, the growth rate or growth e¤ect would increase. Second, as we can see from (3.84), if zU is closer to 1, the …rst term can decrease; even though g may increase but after sometimes (1 zU ) would dampen this e¤ect. Also, from the second term, we have the price ratio PU =PJ ; and the economic intuition behind can be understood from the price ratio: PU = PJ g + (1 + ) aJ (1 zJ ) aU (g + ) g= (1 zU ) If zU increases, g and LU LJ +g !1 would increase but both are constrained by the limits of skilled labour supplies. However, if zU is closer to 1, zU would be closer to and can make economy U ’s price much higher than that of economy J: Even when the price of …nal goods in economy U is very high relative to that of economy J; households in economy U would still consume the products from economy U because in the static utility function, we can see that all varieties are, to some degree, complementary. As such, the households in 193 economy U would cut down the amount of each variety consumed but not cut all. If the relative price of economy U ’s products is too high, relatively large income has to be spent in purchasing goods from economy U: Then, the static utility of economy U can be much lower (this is consumption e¤ect) and overwhelms the growth e¤ect enjoyed by economy U: Another way to understand the mechanism behind the welfare results above is to see the movement of skilled labour. As we subsidize R&D, more skilled labour would be spent in R&D and less on …nal goods production. For economy J; there can be an optimal zU for economy J (see Tables 3.7 and 3.9). Economy J also enjoys the higher growth e¤ect due to the increase in economy U ’s subsidy. However, if the subsidy in economy U increase, we have higher price ratio PU PJ , causing lower consumption of each variety produced by economy U: Since all varieties, produced by both economies, are complementary - as observed in the static utility, for very high value of zU (closer to 1), the consumption e¤ect dominates the growth e¤ect, causing lower welfare. Also, from Table 3.8, we can see that the subsidy rate of economy J does not help its own economy. As you can see the welfare drops as we increase subsidy rate of economy J while …xing zU : Economy U would enjoy a little from very small positive amount of zJ ; 0.02. This is because the contribution of branch innovations from economy J is little so if economy J subsidizes on its R&D sector, they would not gain much from growth e¤ect (as we can see, g changes very little) meanwhile, the consumption e¤ect is very large. So as a whole, the welfare in economy J would fall as zJ increases. Therefore, plays important role in determining whether the subsidy from economy J is e¤ective. For some higher - meaning the branch innovations from economy J is very signi…cant, we would have growth e¤ect to dominate the 194 aU = 5; HU = 0:5; aJ = 2; HJ = 0:5; LU = 0:5; LJ = 0:5; = 0:3; = 0:035; = 0:6; = 0:3 zU zJ g (%) W.U W.J 0:1 9.094 167.06 159.45 0:2 9.349 170.56 163.24 0:3 9.614 174.08 167.13 0:4 9.891 177.57 171.08 0.5 10.179 180.95 175.07 0.6 10.481 184.13 179.05 0.7 10.797 186.84 182.89 0.8 11.128 188.51 186.28 0.83 11.23 188.62* 186.85 0.9 11.476 187.35 188.31 0.91 11.510 186.86 188.33* 0.92 11.546 186.52 188.28 Table 3.7: E¤ect of economy U’s subsidy under two-labour setting consumption e¤ect for some positive zJ : This claim is shown in Table 3.9 and Table 3.10. Now, the optimal zU for economy U when zJ = is 0.83 while the optimal zJ for economy J when zU = 0:83 is 0.00. This is the corner Nash equilibrium. In Table 3.9, we can see that …xing zJ at zero and varying zU ; we have welfare of economy U would be optimal at zU = 0:6; the optimal zU for economy J is 0.74. Meanwhile, in Table 3.10, we can see a positive e¤ect from subsidy of R&D activities from economy J: The optimal zJ for economy J; given zU being …xed at zero, is 0.12 with the value 49.025. Economy U also enjoys a spill-over e¤ect from the subsidy in economy J; its welfare is optimal at zJ = 0:34: Here, we also have a con‡ict. Economy U would want economy J to subsidize its R&D activity at a rate higher than what economy J wants. From the numerical results, we see that for any given R&D subsidy rate of one economy, the other economy would have the best response with an subsidy rate which is positive. As such, the interior Nash 195 aU = 5; HU = 0:5; aU = 0:5; HJ = 0:3; LU = 0:5; LJ = 0:5; = 0:3; = 0:035; = 0:6; = 0:3 zU zJ g (%) W.U W.J 0 8.850 163.61 155.76 0:12 8.863 163.62* 155.52 0:2 8.877 163.57 155.18 0:3 8.890 163.45 154.68 0:4 8.904 163.25 154 0.5 8.919 162.91 153.05 0.6 8.933 162.4 151.72 0.7 8.948 161.6 149.78 0.8 8.962 160.29 146.73 0.9 8.978 157.8 141.02 Table 3.8: E¤ect of economy J’s subsidy under two-labour setting equilibrium is: zJ = 0:14 and zU = 0:60, with the corresponding welfare of economy U being 64.537 and that of economy J being 55.64. However, if the two economies cooperate with one another on setting the subsidy rates to obtain the best combined welfare, economy J would choose zJ = 0:22 and economy U would choose zU = 0:76: With these, the highest total welfare that can be achieved through R&D subsidies is 120:49, where economy U ’s welfare is 64:494 and economy J’s welfare is 55:993. That is to say, if the governments of the two economies were to set the R&D subsidy rates on their own, they would naturally set the rates at the Nash equilibrium where they would react towards each other’s subsidy policy. Therefore, in order to achieve the social optimal level, there must be a cooperation from the two economies to set their respective optimal subsidy rates. Yet, cooperation might incur risk of one economy deviating because given the subsidy rates that achieves best combine welfare, one would rather want to deviate from it because the subsidy rate that it has now is not the optimal given the other’s choice of subsidy rate. Consider the case where one economy faithfully 196 aU = 14; HU = 0:5; aJ = 7; HJ = 0:5; LU = 0:5 LJ = 0:5; = 0:3; = 0:035; = 0:6; = 0:7 zU zJ g (%) W.U W.J 0 3.291 59.637 48.963 0:1 3.418 60.72 50.149 0:2 3.549 61.747 51.334 0:3 3.687 62.689 52.507 0:4 3.8295 63.49 53.634 0.5 3.979 64.072 54.676 0.6 4.135 64.291* 55.556 0.7 4.298 63.882 56.127 0.74 4.365 63.43 56.208* 0.8 4.469 62.243 56.062 0.9 4.648 57.486 54.346 Table 3.9: E¤ect of economy U’s subsidy under two-labour setting with higher RSE abides to the social optimal level while the other breaks the agreement and chooses its best response subsidy rates. Then the former will su¤er the loss in welfare with respect to its respective social optimal welfare, while the latter will enjoy higher welfare. But the sum of the two economies’welfares is lower than that of the social optimal case. That means the loss in the welfare of the former economy is larger than the gain of the latter one. Thus, if cooperating, whichever economy enjoys more from the "cooperation" in the subsidy rate setting would have to compensate the other enough so that it does not choose to deviate. Summarizing all, we have the following results: Result 4: There is an optimal subsidy rate for economy U given economy J’s choice of subsidy rate. Result 5: For certain low values of (or small reverse spill-over e¤ect), it is better for economy J not to subsidize because its welfare can be lower. But for high range of ; the optimal subsidy rate for economy J is positive 197 aU = 14; HU = 0:5; aJ = 7; HJ = 0:5; LU = 0:5 LJ = 0:5; = 0:3; = 0:035; = 0:6; = 0:7 zU zJ g W.U W.J 0 3.291 59.637 48.963 0:1 3.306 59.801 49.024 0.12 3.309 59.829 49.025* 0:2 3.322 59.922 48.988 0:3 3.338 59.984 48.823 0.34 3.344 59.988* 48.710 0:4 3.354 59.965 48.481 0.5 3.371 59.836 47.896 0.6 3.389 59.537 46.943 0.7 3.407 59.113 45.404 0.8 3.425 57.917 42.787 0.9 3.444 55.717 37.558 Table 3.10: E¤ect of economy J’s subsidy under two-labour setting with higher RSE and …nite. Our results show that the more R&D activities in economy J are encouraged, the higher the growth rate. Whereas in Yin and Keith (2010), more labour spent on innovating in the South (the counter part of economy J in this model) would reduce the growth rate if the reverse spill-over e¤ect is small. The reason is that in their research, they allow for imitation as a force that takes away the business of the …rm in the North (the counterpart of economy U) which induces less innovation in the North. If the South focuses more on innovations and less on imitations, the direct e¤ect that less labour is available for the multinationals, thus lowering the multinationalization rate. There is competition e¤ect which works opposite of this direct e¤ect: more multinationals will move to the South to make use of the lower cost, thus pushing up the multinationalization rate. If the direct e¤ect dominates multinationalization rate is low, more labour being locked in the production 198 Figure 3.3: Welfare of economy U under two-labour case. Parameters: HU = 0:5, HJ = 0:5; LU = 0:5; LJ = 0:5; aU = 5; aJ = 2; bU = 1; bJ = 0:3; = 0:035; = 0:6, = 0:7 Figure 3.4: Welfare of economy J under two-labour case. Parameters: HU = 0:5, HJ = 0:5; LU = 0:5; LJ = 0:5; aU = 5; aJ = 2; bU = 1; bJ = 0:3; = 0:035; = 0:6, = 0:7 199 sector in the North and less on the North’s R&D activities. So, if the South’s innovations contribute little to the world’s knowledge pool, the e¤ect of lower multinationalization rate dominates the contribution of the South’s innovation, causing lower growth. In Yin and Keith (2010), it is interesting that when the competition e¤ect dominates at a high imitation rate and the reverse spill-over e¤ect is zero, the global growth rate is still lower as imitation rate increases. Now if the South’s innovations are more signi…cant, the contribution from the South can boost the global growth rate because the knowledge pool is larger. In our model, there is no imitation by economy J but only innovations; whether economy J innovates, it does not a¤ect economy U’s …rms. There is no labour movement necessary to be made. Our research goes one step further, that is not done in other studies as far as we know, to see how the welfares of the two economies would varies with the subsidy rates. We …nd that for a weak reverse spill-over e¤ect, the optimal subsidy rate for economy J given economy U’s subsidy rate can be zero. This is because the growth e¤ect is less than the consumption e¤ect in economy J. However, for a strong reverse spill-over e¤ect, the optimal subsidy rate for economy J is positive and …nite. As for economy U, there is a positive and …nite optimal subsidy rate for any given subsidy rate of economy J. The interaction in setting subsidy rates produces a Nash equilibrium. 3.5 Conclusion We have examined open economic setting with one being a leader (economy U) in innovation while the other (economy J) making use of the concepts of the innovations produces branch innovations. Economy J’s branch innovations have similar concepts with the original innovations but have di¤erent applicational values. The branch innovations are allowed to have some re- 200 verse spill-over e¤ect, which is not seen in other works. The importance of the knowledge of branch innovations in the global knowledge pool a¤ects many key results in this chapter. We study how subsidy policies in each economy would a¤ect the global growth rate, welfares of the two economies and as well as how they interact with each other. Our analysis shows several new results. First, the subsidies in both economies will always increase the global growth rate but they will not necessarily increase economy J’s welfare even for a very small amount of subsidy. Only when the reverse spill-over e¤ect from the branch innovation is strong enough, does the welfare of economy J increase for a small amount of subsidy. This also leads to the second point that there exists an optimal subsidy rate for economy J given economy U’s choice of subsidy if the reverse spill-over e¤ect is large enough. Meanwhile, there always exists an optimal subsidy rate for economy U given economy J’s choice of subsidy rate. The interaction of the two economies’choices of subsidy rates gives us a Nash equilibrium where no economy wishes to change their choice. Thirdly and also lastly, we introduce skilled and unskilled labour into the model and analyse the wage inequality. We …nd that the wage ratio within an economy and the wage ratios between the wage rates of skilled workers and between the wage rates of the unskilled workers in economy U and economy J would be higher if the reverse spill-over e¤ect is stronger. 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Secondly, is there any way that these economies can cooperate in policy-making in order to achieve higher welfare? Many studies on open economies look at the North-South setting...Summary My thesis studies how the public policies would a¤ect economies in term of growth and welfare in the open economy setting Most of the studies on public policies are either on closed economy or on open economies with North-South setting where the North comes out with the new innovations from which variety of products come and the South learns to imitate the innovations from the North and produce... optimal patent length for the innovating economy while the standardizing economy should have in nite patent length The third chapter speci…es two economies whose symmetry is in between the two cases in the …rst two chapters There is a leading economy (U) which produces original innovations and a following economy (J) which makes use of the original innovations and produce innovations that have the similar... (2012) look at how subsidies in terms of lowering the entry costs in a two -open- economy model but they focus more on the relationship of entry subsidies in the Nash equilibrium and the level of trade freeness3 In this research, we employ the endogenous growth model with variety expansion and focus on the R&D subsidy policies in open economies 3 Subsidizing …rm entry in open economies 4 of similar characteristics4... rate of innovations rises, bene…ting the society Another interesting point in this model is that besides spill-over of knowledge within an economy, we have another level of knowledge spill-over across the economies Ertur and Koch (2011) make use spatial econometrics to study the global interdependence by looking at international R&D spillovers They …nd that increasing R&D expenditures by 1% in USA would... varieties Continue to be manufactured Continue to be manufactured CHAPTER THREE’S STRUCTURE OF THE WORLD ECONOMY Chapter 1 R&D subsidies in open symmetric economies 1.1 Introduction Economists using endogenous growth models have focused their studies on how R&D subsidies a¤ect growth and welfare in a closed economy settings and very few studies have been done on the welfare in the open economies In a closed... original ones - being implemented in di¤erent technological applications We call economy J’ innovations as branch innovations Here s we allow the branch innovations to have feedback e¤ect on the knowledge pool of the North First, we examine the economies with elastic homogenous labour - that is, labour can be used in both R&D and manufacturing sectors After that, we introduce two types of labour in. .. subsidies perform better in improving the welfare than the subsidies of purchasing intermediate goods; however, there exists a combination of both kinds of subsidies that outdo both individually Gomez and Sequeria (2012) look at the optimal R&D subsidies to eliminate three 1 Depending on the model speci…cation, we can have over-investment For example, Comin (2004) suggests that when the R&D investment contribute... consists of two economies of similar structure In this setting, the world economy has two economies, each of which engages two activities of production: …nal goods and innovations (R&D) And in both sectors, the only factor in production is labour In this model, some labour would be spent in R&D sector where they would create innovations which are the new ideas of producing …nal goods After one innovation . to look into these questions through examining subsidies on R&D. In globalization era where economies join in World Trade Organization, many economies, facing restrictions in trade policies. welfare in the open economy setting. Most of the studies on public policies are either on closed economy or on open economies with North-South setting where the North comes out with the new innovations from. –that is all in- 5 novations produced by the innovating economy; (2) knowledge that includes only those products whose patents are expired in the innovating economy; (3) knowledge that includes only