This paper reconsiders the well-worked topic of strategic trade policy, but we approach the topic from a novel and important perspective. We observe that previous work on strategic trade policy with regard to R&D subsidies, starting with the seminal paper by Barbara Spencer and Jim Brander (1983), has proceeded under the implicit assumption that firms have perfect property rights to the results of their R&D investments. In reality, of course, the protection of intellectual property rights (IPRs) is not perfect. So it is natural to consider optimal choices for these policies in tandem rather than examining R&D subsidy policy in isolation.

We show that the level of IPR protection can have important implications for a government's incentives to intervene in the R&D decisions of domestic firms.We treat the level of IPR protection as exogenous, and consider how weak IPR protection may affect the case for an R&D subsidy in an international duopoly setting. When IPR protection is perfect, the model is identical to the original Spencer and Brander setup, and exhibits its well-known features. A firm's profits rise when its rival undertakes smaller amounts of R&D, and so governments seek to reduce the R&D levels of rival firms with their R&D policies. As a firm's best response to an increase in R&D by its rival is to reduce its own R&D (i.e., R&D reaction curves slope down), the domestic government will wish to subsidize R&D because, in providing the domestic firm with an incentive to do more R&D, the government is able to discourage R&D activity be the foreign rival firm.

However, in the presence of imperfect IPR protection, a novel force comes into play in determining government incentives to intervene in firm R&D choices: a rival's R&D now directly reduces one's own costs as well. If IPR protection is sufficiently weak, we show that R&D reaction functions will in fact slope up, so that a prediction of R&D subsidies will again obtain. But now it is fore precisely the opposite reason found in the original Spencer and Brander logic: the domestic government will wish to subsidize its firm's R&D in the presence of sufficiently weak IPR protection, because in providing the domestic firm with an incentive to do more R&D, the government is able to encourage R&D activity by the foreign rival firm, and the greater R&D investments of the foreign rival increase the profits of the domestic firm.This paper is useful in that it succeeds in identifying and characterizing the interesting effects that exogenous variation in the degree of IPR protection can have on standard strategic trade policy arguments. In pointing out the importance of the IPR regime for understanding the incentives to subsidize R&D, and even for predicting the sign of the optimal strategic R&D policy, we also set the stage of future research, which models the joint determination of R&D subsidies and IPR regime.

Executive Summary
I. Introduction

II. Patent Protection and Enforcement
A. Patents
B. Foreign Patents and Treaties
C. Patent Protection Enforcement

Ⅲ. The Model
A. Overview
B. Subgame Perfect Equilibrium
C. Nash Equilibrium
D. The Optimal R&D Subsidies
E. The Unique Patent Protection Enforcement
F. The Optimal Intervention of Both Countries

IV. Conclusion

Appendix A: Proof of Proposition 2
Appendix B: Proof of Proposition 6

References