The authors analyze a dynamic North-South model of innovation, technology transfer, and trade. Northern firms conduct R&D using labor, which has alternative uses producing in the R&D sector or a nontraded good sector. Since technology trans fer prevents the North from fully appropriating benefits of R&D, the optimal rate of innovation for either profit-maximizing firms or a ut ility-maximizing northern planner is less than globally optimal. An i nceased transfer rate intensifies competition of lower wage southern workers with northern workers in production, so profit-maximizing Nor thern firms reallocate labor toward R&D. Copyright 1987 by The Review of Economic Studies Limited.
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