This paper provides a theoretical framework to explain why governments seek restrictions on IPR protection and allow R&D subsidies through multilateral trade agreements such as the TRIPS Agreement and the Agreement on Subsidies and Countervailing Measures. After 7 years of discussion, the Uruguay Round extends GATT's trade-liberalizing philosophy to worldwide use of subsidies as a secondary means to intervene in international trade.

Through the Agreement on Subsidies and Countervailing Measures the WTO tries to preserve one of basic principles of GATT's philosophy: Fair Competition. The principle of Fair Competition is of particular importance in understanding the WTO. To harness GATT's trade liberalizing philosophy, the WTO as a successor of GATT takes this principle as objectives that are pursued through the enforcement and implementation of other principles, for instance the non-discrimination and reciprocity. As an example of the fair competition principle, the WTO prohibited any type of export subsidies through the Agreement on Subsidies and Countervailing Measures, but allowed R&D subsidies. The allowance of R&D subsidies by the WTO is a puzzle because it is well known that R&D subsidization forms the prisoners' dilemma when governments are active to set R&D policy.

In order to find any reasonable logic to explain this puzzle, we focus on the interaction between strategic trade policy tools: R&D subsidization and IPR protection. Indeed, at an international level IPR protection has been a major focus of negotiations along with R&D subsidies. The WTO also requires member countries to strongly enforce patent protection through the TRIPS Agreement. In our analysis, it turns out that it is globally optimal to perfectly disseminate knowledge without IPR protection and to subsidize inventive firms by solving a problem that the weak IPR protection damages firms' incentive to invest in R&D activities. However, current trade agreements do not match with our global optimum. We show that exporting countries may benefit at the expense of importers from a trade agreement to demand stronger enforcement on IPR protection because exporting countries experience the prisoner's dilemma problem when both countries free ride on the rival firm's R&D outcome. Therefore we conclude that it is possible to understand the TRIPS Agreement as an inefficient victory of the interests of northern exporting countries over those of southern importing countries.

Executive Summary

Ⅰ. Introduction

Ⅱ. The Model
A. An Extended SB Model to Analyze the Trade Policy Mix
B. Non-Cooperative Policy Choices without any Binding Agreement

Ⅲ. The Agreement on Subsidies and the TRIPS Agreement
A. The Agreement on Subsidies and Countervailing Measures
B. The TRIPS Agreement

Ⅳ. Trade Policy Mix under the WTO
A. Global Welfare Maximization
B. The Joint Optimum among Exporting Countries in the Absence of R&D
Subsidization

V. Conclusion

Appendix A: Proof of Proposition 1

Appendix B: Global Optimum

Appendix C: The Joint Optimum in the Absence of R&D Subsidization

References

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