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Industrial Research and Development and Real Exchange Rate Depreciation in a Small Open Economy

To examine how changes in relative national prices affect innovation input, this paper studies the impact of changes in industry-specific real exchange rates on manufacturing R&D in a small open economy. For this purpose I introduce a partial equilibrium model of R&D investment. Under some regularity conditions about pass-through elasticities, the model predicts that an increase in price competitiveness may adversely affect the R&D expenditures of a representative firm. Employing dynamic panel data estimation techniques, I use industry-level observations from Korea to test the predictions of the model. The results reveal that a lagged depreciation in the effective real exchange rate has a negative impact on current industrial R&D expenditures. Particularly, this adverse effect is evident among highly concentrated industries with high export shares, which are expected to have relatively low pass-through elasticities.