The impact of parallel imports on investments in cost-reducing research and development

We develop a two-country model of endogerious investment in process innovation by a manufacturer facing competition from parallel imports (PI). We find that the distortions associated with PI inhibit innovation. However, the difference between the manufacturer's expected profits under successful and failed innovation is U-shaped in the cost of engaging in PI. Thus, the reduction in R&D investment depends oil both legality of PI and transport costs. The reduction in innovation could harm global welfare, depending oil whether the manufacturer was deterring PI with a high wholesale price. If so, banning such trade would raise expected welfare. (c) 2005 Elsevier B.V. All rights reserved.