Empirical studies have found that decentralized economies typically underinvest in research and development (R&D). This paper shows that to promote R&D investment, the innovating North's optimal subsidy rate may not necessarily fall in response to the imitating South's strengthening intellectual property protection (IPP), depending on the elasticity of demand for innovative goods. As numerical simulations indicate, if the demand is less elastic, a tightening of Southern IPP (increase in patent life) tends to allow the self‐interested North a smaller optimal subsidy rate. Yet, this relation is overturned if the demand is elastic enough. I also find that worldwide welfare maximization requires a regime of Southern IPP that is neither as stringent as the North favors nor as lax as the South prefers.
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