Better technology may be sold for a lower fee: The ad valorem tariff and licensing contract

The main purpose of this study is to investigate how a relationship arises between an ad valorem tariff and licensed technology in a licensing contract. To this end, we study a two-country, two-firm duopolistic trade model. We consider a product market in which a high-tech foreign firm can license its production technology to an importing country. The government of the importing country chooses an ad valorem tariff rate but has no commitment power. In our model, the home government raises the tariff rate as the licensed technology improves. Our two main results in the case that a highly productive technology is licensed are paradoxical: First, better technology is sold for a lower fee in a licensing contract. Second, the profits of both the licenser and licensee decrease as the licensed technology improves. In other words, cost reduction reduces the profits of both the licenser and licensee. These findings indicate that because of the role played by the ad valorem tariff, technology licensing does not always benefit both the licensee and the licenser.