The technology gap and the limit of imitation: An inspection of the strategy of ‘exchanging market for technology’

Has China's strategy of 'exchanging market for technology' been successful? This paper analyses the effectiveness of this strategy based on the duopoly model of vertical product differentiation by Choi and Shin (1992). It is shown that the outcome is influenced by technology gap and absorptive capacity. The profit of a developing country firm shows an inverted U-shaped relationship with its technology level when holding the foreign firm's technology level constant. In the process of technology improvement by imitation, the developing country firm faces a limit on imitation. A developing country may benefit from the strategy of 'exchanging market for technology' at the early stage and needs to bring in FDI with advanced technology so that it can overcome restraints from the limit of imitation. For one with a smaller technology gap with the home country of FDI, the country in the long run has to achieve technological progress through innovation.