FDI and Technology Spillovers Under Vertical Product Differentiation

When Northern firms undertake FDI in the South, the superior technology they bring to their Southern operations spills over to Southern firms. Technology spillovers accompanied by FDI often enable Southern firms to enhance their product quality. This paper explores a model that incorporates quality-enhancing spillovers in an international duopoly model of vertical product differentiation. We find that the Northern firm, when it chooses to undertake FDI, strategically reduces its product quality to reduce the amount of technology that spills over to the Southern firm. This strategic quality reduction, which is often observed in reality, plays a critical role in welfare consequences and policy implications of quality-enhancing technology spillovers