Economic integration can concentrate resources and abilities of member countries. It can also strengthen economic development of countries in the group.
Among several economic integrations, Free Trade Agreement is the most popular. So far, seeking trade partners and signing Free Trade Agreement have already become the policies emphasized by many governments. Free Trade Agreement can positively enhance GDP, international trade, and social welfare of all member countries.
However, there are always pros and cons in government policy. Signing FTA will benefit some industries, but it will also cause negative impact on the other industries.
In view of this, this article discusses how will signing FTA affects the profits of competitive firm and uncompetitive firm, and social welfare. Furthermore, this article investigates the cases of uncompetitive firm engages in R&D efforts by itself and the government’s R&D subsidies within WTO regulation after signing FTA.
On this research, we find that after home country signing FTA, exemption of tariff obstacle for domestic competitive exporting firm and foreign competitive firm entering into the domestic market can bring positive effects on profit of domestic exporting firm, consumer surplus, and social welfare. However, as long as domestic uncompetitive firm becomes more differentiation with foreign competitive product, then uncompetitive domestic firm will be hurt. In addition, if the foreign competitive product is more homogeneous with product of domestic uncompetitive firm, then the domestic uncompetitive firm will be hurt more seriously.
After signing FTA, if domestic uncompetitive firm engages in R&D, it can reduces its cost, decreases negative impact from FTA, and also increases domestic social welfare, but decreases consumer surplus. Furthermore, we find that for industry with large market demand, low price, and comparative low R&D expenses, when
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foreign product can substitute for domestic product (higher than the threshold value), the domestic uncompetitive firm should make its own product having more homogeneity with foreign competitive product through engaging in R&D; when foreign products have differentiation with domestic product (lower than the threshold value), the domestic uncompetitive firm should be more different with foreign competitive product, By doing this, the uncompetitive firm can receive more profits from R&D, but decreases the consumer surplus. When domestic uncompetitive firm is in the industry with small market demand, high price, and comparative high R&D expenses, if its product become more homogeneous (different) through R&D, then the uncompetitive firm’s own profit and social welfare will shrink (increase). For consumer surplus, when product with homogeneity (differentiation), if the product become more homogeneous (different), then the consumer surplus will decrease.
Finally, from the perspective of balance budget, home country government subtracts part of policy rent from beneficial firm and shifts it to subsidize the uncompetitive firm for R&D expenses. We find that the social welfare of government subsidy cases discussed in this article. Besides, when domestic uncompetitive firm is in the industry with large market demand, low price, and comparative low R&D expenses, the home country government subsidy the domestic uncompetitive firm, can further enhance social welfare after the signing of FTA. If domestic uncompetitive firm is in the industry with small market demand, high price, and comparative high R&D expenses, when foreign product is more different with domestic product, the domestic uncompetitive should engage in R&D through its own efforts and government subsidy. When foreign product has high substitution for domestic product, home country government should not subsidy the uncompetitive firm, instead she should tax the domestic uncompetitive firm for the shake of social welfare.
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