Cooperative R&D under uncertainty with free entry

Deposited for Michelle Chart pre e-prints online againIn the last few decades, the effects of cooperative R&D arrangements on innovation andwelfare have played an important role in policy making. The goal of this paper is to analyzethe effects of cooperative R&D arrangements in a model with a stochastic R&D process andoutput spillovers. Our main innovation is to allow for free entry in both the R&D race andthe product market. To determine the desirability of cooperation in R&D environments,we compare three different ways of organizing R&D activities: R&D competition, R&Dcartels, and RJV cartels. In contrast with the literature, we assume that cooperative R&Darrangements do not have to include all of the firms in the industry. We show that sharingof research outcomes is a necessary condition for the profitability of cooperative R&Darrangements with free entry. The profitability of RJV cartels depends on their size. Theimpact of cooperative R&D arrangements on the aggregate level of innovation depends onwhether there are participants in the R&D race who are a part of the cooperative R&Darrangement. If some outsiders choose to participate in the R&D race, the aggregate rate ofinnovation remains unaffected by the formation of a cooperative R&D arrangement. Otherwise,it increases. R&D cartels may be welfare-improving in cases when they cause theaggregate rate of innovation to increase. In such cases, it may be desirable to subsidizethem. Since sharing of R&D outcomes affects the equilibrium number of firms in the productmarket after the R&D race, the consumer welfare effects of RJV cartels are sensitiveto the specification of consumer preferences. Subsidies may be desirable in cases of largerRJVs since they are the ones which are less likely to be profitable