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International Competition, R&D Investment Patterns, and Endogenous Sunk Costs in Canada and the United States, 1987–2002

By Daniel Ershov.

The impact of competition intensity on innovation and research and development (R&D) spending has been much debated in economic literature, although, up to recently, empirical predictions on the issue have not been systematic or consistent. This paper contributes to the empirical literature on competition intensity and innovation by looking at what happens to R&D intensity when competition intensifies through globalization for countries with different levels of productivity (assuming constant relative productivity levels over the period), using the case study of Canada and the United States (U.S.) following the North American Free Trade Agreement (NAFTA). Drawing on the endogenous sunk costs model of John Sutton (1991, 1998), and using Canadian and U.S. industry level data for 1987-2002, this paper finds that although R&D investment increased in both Canada and the U.S. in the period following NAFTA, the relative gap in R&D investment between the more productive country (U.S.) and less productive country (Canada) also increased.

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