Multinationals, technology transfers
and spillovers

Yunyun Wan
July, 2020
Discussion Paper No.2010

GRADUATE SCHOOL OF ECONOMICS
KOBE UNIVERSITYROKKO, KOBE, JAPANMultinationals, technology transfers
and spillovers
Yunyun Wan⇤
July 6, 2020

Abstract
In this paper we investigate whether multinational firms transfer thestate-of-the-art technology to subsidiaries in the presence of unintended
technology spillovers. It is found that the transfer is more likely when
multinationals face (i) higher spillover rates, (ii) fewer local competitors,and (iii) more multinational competitors. “Forced technology transfer”
to local competitors, as observed in China, harms multinationals while
benefiting the host country. With endogenous entry of a local firm, however, there are cases in which forced technology transfer harms the hostcountry.
Keywords: Multinational firms, foreign direct investment (FDI), technology transfer, technology spillovers, forced technology transfer

1

Introduction

Multinational firms are known to transfer older technologies to subsidiaries indeveloping countries than they do in developed countries. Mansfield and Romeo⇤ Graduate School of Economics, Kobe University, Japan. Email: jiangyun.wan@gmail.com

1

(1996) have explained this phenomenon in these words. “Because many newer
technologies are inappropriate for developing countries, or are diﬃcult and expensive to transfer there, we would expect the technology transferred to developing countries to be older than that transferred to developing countries” (p.
738).1 There is another explanation. Since intellectual property protection is lax
in developing countries compared with developed countries, multinational firms
may be less willing to transfer the state-of-the-art technology to subsidiaries
in developing countries lest it fall into the hands of local competitors who willsubsequently use it to their advantage to compete with the multinationals [Leeand Mansfield (1996)]. In this paper we examine this second rationale.
There is a line of research investigating the strategic licensing of vintage technology to a foreign agent in the presence of unintended technology spillover.
For example, Rockett (1990) considers the nature of optimal licensing contracts. Fosfuri (2000) revisits the multinational firm’s access mode selection
problem previously examined by Ethier and Markusen (1996). Both Ethier andMarkusen (1986) and Fosfuri (2000) implicitly assume that licensing is susceptible to technology spillovers while exporting and foreign direct investment (FDI)
are not. This assumption, however, has been contradicted by empirical work
documenting technology spillovers from FDI.2
Some authors have formally analyzed the possibilities of technology spillovers
through FDI. Fosfuri et al. (2001) have developed a two-period model, basedon the work by Ethier and Markusen (1998), in which a multinational firmtrains a local manager at its overseas subsidiary in the first period but cannot
prevent him from becoming a competitor himself in the second period. A similarlabor-turnover model has been proposed by Glass and Saggi (2002). This paper
1 Also see Diwan and Rodrik (1991) for the model investigating the appropriate technology
transfers.
2 See, e.g., Mansfield and Romeo (1980) for U.S. foreign direct investment, Liu (2002) for
China, Kohpaiboon (2006) for Thailand, and Managi and Bwalya (2010) for sub-SaharanAfrican countries.

2

contributes to this line of research, focusing, instead of analyzing the technology
spillover processes, on how market competition influences multinational firms’technology choices for subsidiaries.
We begin our analysis with a simple two-stage model with one multinationaland one local firm. In the first stage, the multinational firm chooses a typeof technology to transfer to its subsidiary in the foreign (host) country. At
the end of the first stage, part of the technical knowledge embodied in thattechnology spills over to the local competitor. We take the spillover rate to be
exogenous, an assumption common in the industrial organization literature (see,e.g., d’Aspremont and Jacquemin 1988) and the FDI literature (e.g., Ghosh etal. 2018). In the second stage, the multinational and the local firm compete ina Cournot fashion.
This model reveals that the multinational firm transfers its state-of-theart technology if the spillover rate is high and a vintage technology when thespillover rate is low. Though counterintuitive, this finding has the following
intuitive explanation. Suppose that the multinational firm can produce each
unit of output with 20 units of local labor under the old technology and 10
units of local labor under the new technology. When the spillover rate is 80
percent, the imitation of the old technology allows the local firm to produce
each unit of output with (5/4) x 20 = 25 units of local labor, while that of the
new technology reduces this labor requirement to (5/4) x 10 = 12.5 units; asaving of 12.5 units in labor for the local firm. If the spillover rate drops to40 percent, the local firm can produce each unit of output with (5/2) x 20 =50 units of labor with the old technology and with (5/2) x 10 = 25 units oflocal labor; a saving of 25 labor units! Thus, the transfer of a newer technology
makes the local firm relatively more competitive at low spillover rates, which
explains why the multinational is more reluctant to transfer the state-of-the-art

3technology when the spillover rate is low.
In section 3, we extend the basic model to allow for product diﬀerentiation,
multiple local firms under linear demand. We also study price-setting behavior.
When the products are less diﬀerentiated, when there are more local firms,
and when the competition is in prices, the market becomes more competitive,
discouraging the transfer the state-of-the-art technology.
The multination also faces tougher competition when there are more multinationals compete in the host country. In this case, however, stiﬀer competition
encourages the transfer of the state-of-the-art technology (section 4). Thus,
the choice of technology depends in part on the type of the competition themultinationals face.
Section 5 extends the model of section 4 to endogenize entry of a local firmand shows that . endogenous entry encourages the transfer of the state-of-theart technology.
The Trump Administration has accused China for forcing in-bound multinational firms to hand over technologies to local Chinese firms as a pre-condition
for market access. In section 6 we extend the models of section 4 and 5 to
examine the consequences of such “forced technology transfer” policy. In China,“technology transfer” is enforced essentially in two ways.3 One is through formation of joint ventures with Chinese partners. An alternative is to seek priorapproval for investment from regional regulators, who however are known toimpose deal-specific requirements for approval, which include submission of thetechnologies used in the subsidiaries and subsequently to pass the information to
the local firms. In this paper, we focus on the second type of forced technology
transfer in two situations.
3 Details of forced technology transfer in China can be found in Hufbauer, G. C. and Lu,
Z., Section 301:US Investigates allegations of forced technology transfers to China (East Asia
Forum, October 3, 2017) and Branstetter, L.G., Forced technology transfer problem - And
what to do about it (Peterson Institute for International Economics Policy Brief June 2018).

4

When forced technology spillover policy is intended to help the existing local
firm acquire foreign technology, the policy of forced technology transfer harms
the multinationals and benefits the local firm and local consumers. When it isintended to help a local firm enter the market, however, the outcome can becounterintuitive; namely, forced technology transfer policy can make every one
worse oﬀ. Section 7 concludes.

2

The duopoly model of technology transfer withspillovers

Suppose a multinational firm’s subsidiary competes with a local firm in a developing country. When does the multinational transfer its state-of-the-art technology to the subsidiary? In this section we address this question in Cournot
duopoly.
Suppose that, thanks to continuous innovations, the multinational firm holds,
in addition to the state-of-the-art technology, a cache of vintage technologies
that can be transferred to the subsidiary. Assume that the technologies available for transfer are represented by the compact set F = [fB , fA ], where fB is
its oldest technology while fA is its state-of-the-art technology. Assume thatfor any f, f 0 2 F , f > f 0 implies that f is a Hicks-neutral improvement of f 0 .
The literature has identified labor turnover and reverse engineering as two
common channels of unintended spillovers.4 Although managers and engineers
may be lured from the multinational firm, however, they may not be able tocarry with them the entire knowledge embodied in the transferred technology.
Similarly, reverse engineering may not result in a perfect duplication of themultinational firm’s technology, especially when it is a process innovation. We
4 See Fosfuri et al. (2001) and Glass and Saggi (2002).

5

thus assume that the local firm can imitate the multinational’s technology f
only with(⇥100) percent accuracy, where

2 (0, 1] denotes the spillover

rate, assumed exogenous. This signifies that if the multinational firm transfers
technology f 2 F to its subsidiary, the local firm acquires the technology f .
If= 1, spillovers are perfect; the local firm acquires the identical technology

the multinational firm has transferred whereas If= 0, the local firm learns

absolutely nothing from the multinational firm’s local presence. We assume, tokeep things simple, that the local firm’s current technology is so ineﬃcient thatit imitates any technology the multinational transfers. We also assume until
section 5 that the multinational cannot force the local firm to exit even withthe transfer of the state-of the-art technology.
In the analysis to follow, we find it easier to work with the set of unit (minimum) cost C = [cA , cB ] instead of with the technology set F , its dual, wherecA represents its state-of-the-art (best) technology fA and cB (> cA ) the oldesttechnology fB . In terms of cost functions, if the multinational firm transfers
technology c 2 C, the local firm acquires the technology c/ (> c).
Technology transfers may impose additional costs to multinationals.A empirical study by Teece (1977) has found that there are great variations in costsof technology transfer across types of multinational activity. Transfer costs
are almost negligible in engineering-based industries such as chemicals, where
technological information can be embodied in equipment and blueprints but are
significant in industries in which information relates to operations of equipment,
quality control, organization and other procedures.5 Teece (1977) has also foundthat an older technology is generally cheaper to transfer than a newer technology,
although this monotonicity may break down as regards really old technologies.
Letting T (c) denote the cost of transferring technology c to the subsidiary, we
5 Interestingly, Teece (1977) has found cases in which transfer costs were less for international than for domestic technology transfer.

6thus assume as a first approximation that T (c) is continuously diﬀerentiable,
and write the first derivative T 0 (c) < 0 and the second derivative T 00 (c) > 0.6
We ignore the cost of imitation to the local firm.7
The main question we address in this paper is when the multinational firmtransfers its state-of-the-art technology to the subsidiary in the presence of technology spillovers. In the remainder of this section we investigate this questionin the two-stage game. In the first stage the multinational firm chooses a technology c 2 C to transfer to the subsidiary. In the second stage, the local firm
acquires the technology c/through technology spillovers and then the two

firms engage in Cournot competition in the homogeneous product market.
Let p(qm + qh ) represent the host-country inverse demand function, whereqm and qh denote the quantities of output sold by the multinational firm (firmm) and the host-country (local) firm (firm h), respectively. The (net) profits
for the multinational firm and the local firm are defined, respectively, by⇡m = [p(qm + qh )c]qm

T (c),

and⇡h = [p(qm + qh )c/ ]qh .

We assume the demand function is continuously diﬀerentiable and weakly concave.
Assumption 1: p0 < 0. p00  0.
In the second stage, the firms choose quantities to maximize the respective
profit, given the technologies. The first-order conditions are
6 Teece (1977) however has also noted the possibility of non-monotonicity; really old tech-

nologies may be very costly to transfer if current generations of managers and engineers are
unfamiliar with such antiquated technologies.
7 Gallini (1992) examines the role of imitation costs.

7@⇡m /@qm = p

c + p0 q m = 0@⇡h /@qh = p

c/ + p0 qh = 0

which can be solved for a (unique) Nash equilibrium (qm (c), qh (c)). Substituting
these quantities, we obtain the equilibrium profit to the multinational firm as⇡m (c). In the first stage, the multinational chooses technology c to maximize
this profit. Diﬀerentiation yieldsd⇡m (c)/dc = @⇡m (c)/@c + (@⇡m (c)/@qh (c))(@qh (c)/@c)=

qm + qm p0 @qh (c)/@c

T 0 (c).

T 0 (c)(1)

The first two terms in the second line highlight the fundamental tradeoﬀ themultinational faces in the presence of spillovers. A unit reduction in the multinational’s cost increases its profit by qm ; that is, @⇡m (c)/@c =qm < 0. Thisis the direct or eﬃciency eﬀect of transferring a newer technology. Without
spillovers, that is all there is. With spillovers, a newer technology reduces the
local firm’s unit cost by 1/

1, as illustrated in the introduction, enabling

the local firm to expand output and decreasing the multinational firm’s profit
by qm p0 @qh (c)/@c > 0. This is the indirect or spillover eﬀect, captured by thesecond term in (1). The multinational’s choice of technology hinges on therelative magnitude of these two opposite eﬀects. When

= 1, the eﬃciency

eﬀect dominates the spillover eﬀect, so d⇡m (c)/dc < 0, resulting in the transferof the state-of-the-art technology. If< 1, a transfer of a newer technology

reduces the local competitor’s cost proportionately more than it does the multinational firm’s cost. Furthermore, the lower the spillover rate, the greater is8this proportionality, as explicated in the introduction. If the spillover rate is
low enough, therefore, the spillover eﬀect can dominate the eﬃciency eﬀect sothat d⇡m (c)/dc > 0; a transfer of a newer technology decreases the multinational’s profit. The presence of the transfer cost T (c) only adds bias against
transfer of a newer technology.
To make the above statement lucid, diﬀerentiate the first-order conditions
to obtain0000

B 2p + p qm@
p0 + p00 qh

0

00

10

1

0

p + p qm C B dqm C B 1
A@A=@
2p0 + p00 qh
dqh
1/

Solving this system, we find that@qh (c)/@c = [(2p0 + p00 qm )/
where

1

C
A dc.

(p0 + p00 qh )]/⌘ 3(p0 )2 + p0 p00 (qm + qh ) > 0. Substituting this derivative into (1) andcollecting terms, we obtain⇢0 2d⇡m (c)/dc = qm 2(p ) (

1

0 00

2) + p p



(

1

1)qm

2qh

/

T 0 (c)(2)

If d⇡m (c)/dc > 0, the multinational transfers an older technology. The firstterm in braces is positive if and only ifif< 1/2. The second term is positive< 1/3 because c < c/ implies qm > qh . Given that T 0 (c) < 0,

< 1/3 issuﬃcient for satisfying the inequality d⇡m (c)/dc > 0. On the other hand, if
is suﬃciently close to one, the expression in braces is negative, so d⇡(c)/dc canbe positive or negative or zero, depending on the marginal cost of technology
transfer. If d⇡m (c)/dc = 0, this determines the optimal technology choice. Ifd⇡(c)/dc < 0, the multinational firm transfers the state-of-the-art technology.

9Proposition 1: (A) If< 1/3, the state-of-the-art technology is nevertransferred. (B) The state-of-the-art-technology is transferred only if

is suﬃ-

ciently close to one.
Proposition 1 contrasts with the conventional view that the multinational isless willing to transfer its best technology when a technology can fall into the
local competitor’s hands. The intuitive explanation of this result reflects twofacts. One is that when two firms use the identical technology due to perfectspillovers then the transfer of the best technology maximizes profit for the multinational firm. By analogy then if the spillover rate is suﬃciently high, there still
exists a strong motive for transferring the state-of-the-art technology. However
as illustrated in the introductory section of this paper, when the spillover rate
is low enough, the transfer of a new technology makes the local firm relatively
more competitive. The optimal transfer strategy reflects the balance of these
two eﬀects.

3

Linear Demand, Product Diﬀerentiation, andPrice Competition

This section has two objectives. One is to sharpen the results in proposition
1. To do so, we firstly assume linear demand and set p00 = 0. Secondly, fromproposition 1 we know that if the transfer cost T (c) rises sharply enough, themultinational will never transfer the state-of-the-art technology. We remove thisbias by ignoring the transfer cost in our subsequent analysis.
Our second objective is to understand how competitiveness of the local market aﬀects the multinational’s technology choice. Competitiveness depends thenumber of local firms and other multinational firms there are in the local market
as well as the degree of product substitutability among them. The market also

10

becomes more competitive when firms compete in prices instead of in quantities.
In this section we first consider the eﬀects of multiple local firms and the degreeof product substitutability, and then the eﬀect of price competition. The caseof multiple multinational firms is discussed in the next section.
Assume that the multinational firm competes with n

1 local firms and thatits product is diﬀerentiated from the locally produced products (for simplicity,
the locally produced goods are considered homogeneous). Firms still compete
in quantities.
Suppose that the local firms are symmetric and produce Qh units of output
collectively. A typical local firm produces qh = Qh /n. The demand functions
faced by the multinational and by a typical domestic firm are given bypm = aqm

bQh

ph = aQhbqm

where b 2 [0, 1] measures the degree of product substitutability. Assume thatthe spillover rate is common to all local firms, which results in symmetry among
local firms. The multinational and a typical local firm receive the profits ⇡m =(pmc)qm and ⇡h = (phqm (c) =qh (c) =c/ )qh , respectively. The equilibrium quantities are(n + 1nb)a (n + 1)c + nbc/
2(n + 1) nb2(n + 1nb)a (n + 1)c + nbc/
2(n + 1) nb2

The multinational firm’s profit equals ⇡m (c) = qm (c)2 . Diﬀerentiating, we obtaind⇡m (c)/dc =(n + 1) + nb/
qm .
2(n + 1) nb2
11

Thus the multinational transfers the state-of-the-art technology if and only if> nb/(n + 1).
Observing that the right-hand side expression is increasing both in b and in ngives us
Proposition 2 Under linear demands with product diﬀerentiation:(a) The multinational firm transfers the state-of-the-art technology if andonly ifnb/(n + 1).

(b) The multinational firm is less likely to transfer the state-of-the-art technology when it competes with more local competitors or when its product ismore substitutable to the local firms’ products
Setting n = b = 1, we can sharpen proposition 1.
Corollary 1. Under linear demand with n = b = 1, the state-of-the-art
technology is transferred if and only if> 1/2 .

More generally, linear demands make the multinational’s profit function convex in c 2 [cA , cB ] so the multinational transfers the state-of-the-art technology
cA if> nb/(n+1) and cB if< nb/(n+1). If= nb/(n+1), the multinationalfirm is indiﬀerent among all the options.8
Proposition 2 says that the transfer of the state-of-the-art technology isless likely when the market is more competitive in that there are more local
competitors and there is less of product diﬀerentiation. Since competition is
tougher in price competition than in quantity competition, we expect a similar
result from price competition. To verify this expectation, consider the Hotelling
duopoly model, where consumers are distributed uniformly over the unit line
[0, 1] while the multinational and the local firm occupy the end points 0 and 1.
8 The corner solutions can be avoided if the transfer cost is retained.

12

The equilibrium price is

pm = (3t + 2c + c/ )/3;
ph = (3t + 2c/ + c)/3,
where t is the unit ’transportation’ cost. The multinational firm produces

qm (c) =3t

c + c/
6t

and earns the profit ⇡m (c) = (qm (c))2 . Diﬀerentiating, we findd⇡m (c)/dc = qm ( 1 + 1/ )/6t > 0
for all< 1.

Proposition 3. In the Hotelling model, the multinational firm never transfers its state-of-the-art technology for all

4

< 1.

Competition among multinationals

A multinational firm may also face competition with other multinationals in thehost country. How does the rivalry among multinationals aﬀect the technology
choice? In this section we consider this question.
Suppose that M symmetric multinational firms have the identical technology
set C. To keep things simple, let us suppose that they face a single local firm
and that all firms produce homogenous goods. The game proceeds as follows. In
the first stage M multinationals labeled by i = 1, 2..., M simultaneously choose
technologies ci 2 C to transfer to their subsidiaries in the host country. Assume
that all multinationals’ technologies spill over to the local firm so that the local
firm imitates the best technology available. Thus, the local firm acquires the13technology
ch = min(c1 , c2 , , , , , cM )/ ,In the second stage, all firms compete in quantities. A typical multinational
i has the profit⇡i = (a

X

qi

qj

qh

ci )qi .

j6=iwhile the local firm has the profit:⇡h = (aXqiqhch )qh .

i

In equilibrium they produce

qi = (a(M + 1)ci +X

cj + ch )/(M + 2)

j6=i

qh = (a +X

ci(M + 1)ch )/(M + 2).

iMoving back to the first stage, each multinational i chooses technology ci tomaximize the profit⇡i = (qi )2 = [a(M + 1)ci +X

cj + ch ]2 /(M + 2)2

(3)

j6=i

given the other multinational firms’ technology choices cj .
Definec i = min(c1 , c2 , , , ci 1 , ci+1 , , , , , cM )Then the local firm has the technology ch = min(ci , c i )/ .
If multinational firm i chooses a technology ci < c i , then ch = ci / so that14

(3) is written⇡i = [a(M + 1)ci +X

cj + ci / ]2 /(M + 2)2

j6=i

We have that@⇡i /@ci = 2[ (M + 1) + 1/ ][a(M + 1)ci +X

cj + ci / ]/(M + 2)2 .

j6=i

If

> 1/(M + 1), @⇡i /@ci < 0 so multinational i transfers the state-of-the-art technology. If< 1/(M + 1), @⇡i /@ci > 0 so it transfers the technology

ci = c i .
Alternatively, if multinational firm i transfers ci

c i , then ch = c i so the

profit in (3) is decreasing in ci . Therefore, multinational firm i transfers thetechnology ci = c i for all> 0. Now it is straightforward to demonstrate

Proposition 4. Suppose that M

2 symmetric multinational firms com-pete with one local firm. With Cournot competition, homogeneous goods andlinear demand, the following are the subgame-perfect Nash equilibrium outcomes.
(i) For> 1/(M + 1), all multinationals transfer the state-of-the-art tech-

nology cA .
(ii) For< 1/(M + 1), all multinationals transfer any identical technologyc 2 [cA , cB ].
(iii) The more multinationals there are, the more likely the state-of-the-art
technology is transferred.
Two remarks are in order. First, result (ii) says that there is a continuumof subgame-perfect Nash equilibria if< 1/(M + 1). However, the equilibrium

profit⇡i = (a2c + c/ )2 /(M + 2)215

is monotone increasing in c, so in the Pareto-dominant equilibrium all multinationals transfer the oldest technology. Second, result (iii) contrasts sharply
with proposition 2. Proposition 2 says that increased competition discourages
transfer of the state-of-the-art technology while proposition 3 says the opposite. With more multinationals competing, even if the local firm acquires abetter technology and expands its output, its eﬀect is spread out among all themultinationals, causing each multinational to suﬀer only a small loss of market share. On the other hand, each multinational can capture a large market
share by transferring the state-of-the-art technology, given other multinationals’ technology choices. Thus, unilateral transfer the state-of-the-art technology
expands each multinational’s market share and hence its profit. This explains
proposition 3.
In contrast, with more local competitors, a technology spillover causes all
local firms to expand output, causing a large loss of market share for the multinational firm and this loss is greater, the more local firms there are. The prospectof a large loss of market share discourages transfer of the state-of-the-art technology. This accounts for proposition 2.

5

Entry deterrence

As we have seen, the multinationals do not transfer the state-of-the-art technology when the spillover rate is low and when they face tougher competition fromthe local firms. How do these results change if the multinationals can force thelocal firms to exit the market, or equivalently if they can deter entry of local
firms? We turn to this question in this section.
Suppose that M multinationals face a single local firm, as in section 4. The
game is modified as follows. In the first stage, M multinationals simultaneously choose ci to transfer to their respective subsidiaries. In the second stage,
16

the local firm obtains the best technology among the transferred technologies
through spillovers and decide whether to enter the market (equivalently, to exit
the market). If the local firm stays out (or exists), M multinationals compete
in quantities. If the local firm is in the market, M + 1 firms compete. In theanalysis below we focus on the entry version of the model (the analysis of exit
is analogous).
Suppose that all multinationals transfer technology c. Then, if the local firm
enters, it has the net profit

vh (c) = [a(M + 1)c/ + M c]2 /(M + 2)2ewhere e > 0 is the fixed entry cost. Let cD denote the value of c at which theabove expression vanishes:vh (cD ) = [a(M + 1)cD / + M cD ]2 /(M + 2)2

e=0

(4)

We call cD the deterrence technology because entry is deterred when all
multinationals transfer cD or an older technology. Assume that entry deterrenceis feasible.
Assumption 2: cD 2 (cA , cB ].
Assumption 2 implies that vh (cA ) > 0; entry occurs if the state-of-the-arttechnology is transferred.
If entry is deterred, each multinational firm receives the profit⇡ D = (acD )2 /(M + 1)2(5)(no multinationals transfer an older technology than cD ).
Proposition 5. Suppose that M

2 symmetric multinationals face one

17

local entrant and focus on the Pareto-dominant equilibria. With Cournot competition, homogeneous goods and linear demand, the following are the subgameperfect Nash equilibrium outcomes.
(i) If< 1/(M +1), all multinationals transfer technology cD to deter entry.

(ii) If> 1/(M +1), all multinationals transfer technology cD to deter entry

if and only if(M +1) [1/(1 + M )] {a[(M + 1)/p
M ]cA }+(M 2 +M +1)(M +2) e > 0.
(6)

(Proof in the appendix)For< 1/(M + 1), without entry deterrence the multinationals transfer theoldest technology (proposition 4) while with entry deterrence they transfer thedeterrence technology. In the latter case the multinationals profits are greater
because (i) they use the deterrence technology which is more eﬃcient thanthe oldest technology and (ii) they do not complete with the local firm. But
these are the profits the multinationals must forgo if transfer the state-of-the-art
technology. In other words, the transfer of the state-of-the-art technology has
a higher opportunity cost when entry deterrence is possible. For this reason,
although they transfer the state-of-the-art technology without entry deterrenceif> 1/(M + 1), this condition is not suﬃcient when entry deterrence is apossibility; suﬃciency requires that condition (6) be reversed.
It is straightforward to show that (6) is more likely to hold when a is low, cA
is high and e is high. A low demand (a) and a high cA imply that the state-ofthe-art technology does not increase the multinationals’ profits sharply. A highentry cost e implies that entry can be deterred with a more eﬃcient deterrencetechnology, resulting in greater profit. Thus, when (6) holds, the multinationals
deters entry although> 1/(M + 1).

Proposition 6: Given> 1/(M + 1), the state-of-the-art technology is18

more likely to be transferred when(i) the host-country market demand (intercept) is greater,(ii) the local firm has a lower entry cost,(iii) the state-of-the-art technology is relatively more eﬃcient.

6

Forced technology transfer

As mentioned in the introduction, China has been accused of demanding complete disclosures of the technologies from multinationals as a pre-condition formarket access. The problem for multinationals is that the technical information
embodied in that technology is often passed on to the local firms. What is theconsequence of such a policy? In this section we address this question.
This policy is commonly known as “forced technology transfer.” Here, however, it is renamed “forced technology handover” or FTH for short, as consistency
demands that the term “transfer” refer to the installment of a technology by amultinational in its subsidiary.
Suppose that the multinational(s) cannot deter entry and consider the equilibrium in which the multinationals transfer the state-of-the-art technology inthe absence of FTH. Then, since “forced technology handover” is equivalent tosetting= 1, FTH has no impact on the choice of technology by the multi-

nationals. However, FTH enables the local firm to acquire the state-of-the-art
technology cA and makes it more competitive, implying lower profits for themultinationals and increased profit for the local firm. The acquisition of a more
eﬃcient technology by the local firm boosts industry output, lowering the priceto the benefit of consumers.
Consider alternatively the cases in which the multinationals transfer the oldest technology without FTH. Then the transfer of the state-of-the-art technologythat occurs under FTH precludes the optimal technology transfer and results
19

in lower profits for the multinationals, while the acquisition of the best technology raises profit to the local firm and the higher output that results benefits
consumers.
Proposition 7. In the models of sections 3 and 4, where the possibility ofentry deterrence is ruled out, forced technology handover decreases the multinational firm’s profit while increasing the local firms’ profits and the host-country’s
consumer welfare.
Next, let’s take a look at how the results above change if entry is endogenous.
To investigate this question, define the deterrence technology e
cD with FTH by(aecD )2 /(M + 2)2

e = 0.

(7)

A comparison of (4) with (7) indicates e
cD > cD ; that is, with FTH it takes anolder and less eﬃcient technology to deter entry. Deterred entry under FTH
assures the multinationals of the profit⇡FDT = (aecD )2 /(M + 1)2 < ⇡ D .

If a multinational firm deviates by transferring the state-of-the-art technology,
entry ensues, yielding the profit⇡Fd T = [a(M + 1)cA + (M1)ecD + cA ]2 /(M + 2)2

for a deviating multinational, and ⇡FDT > ⇡Fd T if and only if
a + M (M + 1)cA

(M 2 + M + 1)ecD > 0.

20

Case
1
2
3
4
5

Spillover rate(6)

< 1/(M + 1)

N.A.

> 1/(M + 1)

Holds⇤
Holds
Fails

(8)
Holds
Fails
Holds
Fails
Fails⇤

Without FTH
No Entry
Entry

With FTHNo Entry
Entry
No Entry
Entry

Table 1: Summary of conditions for entry deterrence
Substituting for ecD , we can rewrite this condition as
M (M + 1)(apcA ) + (M + 2)(M 2 + M + 1) e > 0(8)Thus, if condition (8) holds, there is no deviation from deterred entry.
Proposition 8. Under “forced technology transfer” policy, entry is deterredwith the transfer of the technology ecD if and only if condition (8 ) holds. If

this condition is reversed, the multinational firms transfer the state-of-the-art
technology and accommodate entry.
Condition (8) is more likely to hold when the demand is low, the entry
cost is high, and the state-of-the-art technology is less eﬃcient (cA is higher).
The intuition is similar to the one given before proposition 6. A higher entry
cost makes entry deterrence less costly because the multinationals can use amore eﬃcient deterrence technology. If the demand is low and the state-of-theart technology is not that eﬃcient, its transfer does not raise dramatically themultinational’s profit. Both these facts make entry deterrence more attractive
to multinationals compared with entry accommodation.
The table below compares the equilibrium outcomes with and without FTH
from propositions 5 and 8. (The condition with an asterisk (*) is implied by thecorresponding un-starred condition.)
In cases (1) and (3), entry is deterred with and without FTH. These cases
occur when the demand is low, the entry cost is high and the state-of-the-art

21technology is relatively ineﬃcient; that is, under condition (8). With FTH, themultinational firms transfer the older deterrence technology ecD (> cD ), whichmakes the subsidiaries less eﬃcient and decreases profits. Transfer of the lesseﬃcient deterrence technology also raises the price and lowers consumer welfare.
Thus, FTH makes both the multinationals and the host country worse oﬀ.
In cases (2) and (4), entry is deterred without FTH and accommodatedwith FTH. These cases occur when the demand is high, the entry cost low andthe state-of-the-art technology relatively eﬃcient; that is, when condition (8)is reversed. The host country’s welfare is higher with FTH because the local
firm enters with the state-of-the-art technology instead of being deterred, anda lower price benefits local consumers. Comparing entry deterrence with entry
accommodation, a typical multinational’s profit changes from ⇡ D given in (5)to ⇡FAT = (a⇡DcA )2 /(M + 2)2 . We have that
⇡FAT = (a() acD )2 /(M + 1)2(acA )2 /(M + 2)2 > 0(M + 2)cD + (M + 1)cA > 0.

Substituting for cD , we can write the last inequality asp(M + 1)2 e + a(M + 1)(1/

2) + (M + 1)[(M + 1)/

M ]cA 0(9)

We can show that this condition holds whenever condition (6) holds. Thus, themultinationals are always harmed by FTH.
In case (5), entry is accommodated with and without FTH. Since the local
firm competes with or without FTH, the welfare results are similar to those given
in proposition 7; FTH decreases the multinational firms’ profit while raising the
local firm’s profit and improving host country consumer welfare at the same
22

M =1
M =5
M =8
M = 10No entry/No entry
a < 5.50
a < 8.23
a < 11.14
a < 13.11

No entry/Entry
5.50  a < 9.73
8.23  a < 11.48
11.14  a < 15.57
13.11  a < 18.36

Entry/Entrya 9.73
a 11.48
a 15.57
a 18.36

Table 2: Illustration of Proposition 9time. We summarize the above findings in
Proposition 9(i) FTH always harms the multinationals.
(ii) In cases (1) and (3), entry is deterred with or without FTH. As a result,
FTH also harms the local firm and host-country consumers.
(iii) in cases (2) and (4), entry is deterred without FTH and accommodatedwith FTH. FTH benefits the local firm and host-country consumers.
(iv) In case (5), entry is accommodated with and without FTH. FTH benefits
the local firm and consumers.
Table 2 illustrates proposition 9. To find the ranges of a we fix e = cA = 1
and= 0.7. The descriptions in the top row indicate the equilibrium outcomes

without/with FTH. The table confirms that entry is more likely to be deterred
when the market size is smaller or when there are more multinationals. It also
shows that FTH facilitates entry of the local firm when the market size is in theintermediate range (the middle column).

7Concluding remarks

It is well known that multinational firms transfer older technologies to subsidiaries in developing countries than they do in developed countries. One can
explain this fact by an appeal to the notion of appropriate technology transfer,i.e., the complementarity between technology and skill levels of local workers.
Alternative and complementary to it is another explanation that emphasizes
23strategic aspects of technology transfer. Multinational firms are said to be
reluctant to transfer the state-of-the-art technology to countries with weak protection of intellectual property lest it be used by the local imitator to compete
more aggressively them. In this paper we apply the standard oligopoly models
to evaluate this second rationale and find the result that contrast sharply withit, that is, we find that the multinational firms are more likely to transfer thestate-of-the-art technology when the spillover rate is high.
We also find these results. When the multinational firm faces more local
competitors, it is less likely to transfer the state-of-the-art technology. By contrast, when it faces more multinational rivals, the multinational is more likely
to transfer the state-of-the-art technology. When the local firm’s entry is endogenous, the multinational firms are less likely to transfer the state-of-the-art
technology than when the local firm is already in the market.
We also apply our models to understand the eﬀect of “forced technology
transfer policy”, a common practice in China. When the wholly owned subsidiaries of multinational firms are required to hand over their technologies tothe local governments as a pre-condition for market access, who later pass themon to the local firms, it is no surprise that the multinationals’ profits decrease
and the host country’s welfare rises. With endogenous entry, however, forced
technology transfer policy can be harmful to both the multinationals and tothe host country. This can occur when, for example, the market demand is
suﬃciently small that entry is deterred even under forced technology transfer
policy.
To save space we have analyzed a limited number of cases but it is possible
to explore other possibilities. For example, we can extend our analysis to thecase when the multinationals and local firms export to other national markets.
Another interesting scenario is that the local firm can innovate based on the24acquisition of foreign technology. We leave these extensions for future work.

Appendix
Proof of Proposition 5. Suppose that in equilibrium entry is deterred. If
multinational firm 1, say, deviates by transferring a better technology c1 < cD ,the local firm enters with the acquired technology c1 / , yielding to multinational
1 the profit⇡1d = [a(M + 1)c1 + (M1)cD + c1 / ]2 /(M + 2)2

Diﬀerentiating,@⇡1d /@c1 = 2[a(M + 1)c1 + (Mwhich is positive if and only ifentry is deterred. If

1)cD + c1 / )](1/M< 1/(M + 1). Thus, when

1)/(M + 2)2 ,< 1/(M + 1),> 1/(M + 1), however, @⇡1d /@c1 < 0 so multinationalfirm 1 deviates with transfer of its state-of-the-art technology. Since the local
firm acquires the technology cA / , a defection yields⇡
˜1d = [a(M + 1)cA + (M1)cD + cA / ]2 /(M + 2)2

We find that⇡D > ⇡
˜1d

25

if and only if

a + (M + 1)(M + 1

1/ )cA(M 2 + M + 1)cD > 0.

(10)

Substituting for cD , we can rewrite (10) as(M + 1)[1/(1 + M )]{apM ]cA } + (M 2 + M + 1)(M + 2) e > 0.

[(M + 1)/This condition is more likely to hold when a is small, cA is high and e is also
high.

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