Abstract: The geographical distribution of R&D investment changes dramatically in the 1970s and 1980s. In the early 1970s the distribution is very skewed: U.S. firms are the uncontested world leaders in R&D investment in most manufacturing sectors. Later, led by Japan and Europe, foreign firms start challenging American R&D leadership in many sectors of the economy. What is the effect on U.S. national welfare of foreign innovators entering sectors previously dominated by American firms? What are the implications for the optimal U.S. R&D subsidy? In this paper I build an empirical measure of international R&D rivalry tracking down these changes in international distribution of research efforts. In a version of the quality-ladders growth model I evaluate the quantitative effects of the increase in foreign R&D rivalry observed in the data on U.S. welfare. Using estimates of the effective R&D subsidy rate in the U.S., and the international R&D rivalry index, I compute the distance from optimality of the observed U.S. subsidy at each level of competition in the period 1979-91, and quantify the welfare gains associated with the optimal subsidy.