Returning to Krugman’s simplified model of knowledge spillovers, it becomes apparent
that R&D subsidies to domestic firms are just as likely to benefit foreign rivals if we assume that
most of the knowledge generated is the kind that becomes available internationally. In this age
of telecommunications and low transportation costs, with multinational firms operating across
the globe, the economic boundaries of the state have in many ways withered away. This
changing economic landscape makes it difficult to continue to justify the assumption that the
knowledge generated by firms represents an externality that is internalized within the physical
boundaries of the state. Without this assumption, however, it is difficult to justify the
implementation of an R&D subsidy to achieve either goal of strategic trade policy, whether the
government is attempting to capture rents from a foreign rival or the positive externalities of a
strategic sector. As Spencer concedes, a domestic firm is only a good candidate for an R&D
subsidy if “there is a minimum spillover of new domestic technology to rival firms.”18 This is
problematic because it is likely to be more difficult now to find industries that exhibit such a
“minimum spillover” than ever. If this is the case, then a subsidy which cannot be fully
appropriated by domestic firms essentially represents a gift to rival foreign firms at the expense
of domestic taxpayers.
In regards to the effectiveness of sector-specific subsidies in general, Noland and Pack
conclude in their study of the so-called “Asian Miracle” that targeted industrial policy was only
marginally beneficial to the rates of growth of Japan, Korea, and Taiwan. Specifically, the
authors found that total factor productivity (TFP) growth rates did not support the theory of early
postwar advocates of industrialization that “the entire manufacturing sector, and perhaps the
entire economy, is the beneficiary of widely diffused external economies.” Instead, the TFP
growth which did occur within individual sectors was explained by more conventional
explanations such as learning-by-doing and the importation of foreign technology at the level of
the individual firm.19 This last point, particularly, should give us pause. For contrary to the oft-
proposed notion that “countries are better able to apply new technology if the technology i