Innovation and Firm's International Expansion: A Dynamic Approach

Maria Luisa Petit and Francesca Sanna Randaccio
University of Rome ``La Sapienza"
Petit@peano.dis.uniroma1.it

Boleslaw Tolwinski
ORE, Golden, Colorado

Abstract

The literature that analysis the effects of technological innovation on production and welfare considers firms producing within a single economy and therefore ignores any problems related to firms foreign expansion. On the other hand, the literature on firms' foreign expansion focuses on the trade-direct investment choice and does not take into account the effects of technological innovation.

This paper is an attempt to integrate these two different branches of the literature. We consider an international setting where firms take decisions on both research expenditures (R&D investment) and the level of output, and also take into account the possible choices for foreign expansion through either exports or direct investment. The paper examines the influence of R&D decisions on the form of foreign expansion chosen by the firms, and also how this last choice influences the firms decisions on investment in research. The effects on consumer welfare of the different choices made by the firms are also analysed.

We consider a two country model where duopolistic firms producing in each country have the possibility to serve the other country either by creating there a new plant or by exporting. The models considered are dynamic and refer to both the cases of symmetric and asymmetric firms, where the differences may be due to different past technological accumulation paths or to different rates of innovation. We assume process innovations, where the cost reducing technological innovations are an outcome of the firm's past accumulated capital in R&D.

The models considered describe both cooperative and non-cooperative dynamic (Markov) games between the two international firms. The equilibrium market structure is determined in a three step procedure. In the first step the firms decide on the number of plants. In the second step eqch firm decides the ammount of sales in both contries. The resulting three step game is solved backwards and feedback Nash equilibria are obtained.

Analytical solutions can be obtained for the simple (static) linear cases. More sifisticated nonlinear models and the computation of dynamic equilibrium strategies require the use of numerical techniques. A numerical algorithm has been used based on a modified policy iterationmethod that is capable of computing feedback Nash equilibria for some nonlinear dynamic games outside the standard linear-quadratic formulation.