Credibility of Protection and Incentives to Innovate

Abstract

In recent trade policy debates it is often argued that temporary protection stimulates innovation. This paper shows that the validity of the argument depends on the perceived credibility of protection policy. If it is suspected that temporary protection will be removed early should innovation occur before its terminal date, the protected firm invests less in R&D than it does under free trade. If it is expected that protection will be extended should no innovation have occurred by its terminal date, investment falls below the free‐trade level, and eventually to zero, as the terminal date is approached.