Innovation incentives in an intergrated marketed with vertical product differentiation

This paper examines whether integration of national markets fosters innovation in the technologically inferior country. In a simple set up where a technologically backward home firm and a technologically advanced foreign firm compete in qualities and prices in an integrated market, we find that the outcome depends on the speed of response of the two firms and their initial technological distance. If the domestic firm is not too far behind the foreign firm to begin with, and if it responds faster, then the technological gap may get reversed. Further, we find that integration may be welfare improving for both the countries. There are, however, distributional implications. While the consumers always gain from such integration, the firms may not.