R&D spillovers and the case for industrial policy in an open economy

In this paper we consider the case for subsidies towards firms which genera te R&D spillovers in open economies. We show that in the presence of strate gic behaviour by firms many expected results are overturned. Local R&D spil lovers to other domestic firms may justify an R&D tax rather than a subsidy ; R&D cooperation by local firms over-internalises the externality and also justifies an R&D tax; and international spillovers which benefit foreign f irms may justify a subsidy, even though the government cares only about the profits of home firms.