Cooperative R&D under Uncertainty with Free Entry1

In the last few decades, the effects of cooperative R&D arrangements on innovation and welfare have played an important role in policy making. Both the US and the EU have legislation in place providing for lenient antitrust treatment of such cooperative agreements. The goal of this paper is to analyze the effects of cooperative R&D arrangements in a model with a stochastic R&D process and output spillovers. Our main innovation is to allow for free entry in both the R&D race and the product market. To determine the desirability of cooperation in R&D environments and optimal antitrust policy, we compare three different ways of organizing R&D activities: R&D competition, R&D cartels, and RJV cartels. In contrast with the literature, we assume that cooperative R&D arrangements do not have to include all of the firms in the industry. Hence, the cartel members potentially face competition from outsiders both in the R&D race and the product market. The assumption of output spillovers together with free entry raises the prospect of innovation causing exit initially and entry later on. Our main conclusions are as follows. R&D cartels are always unprofitable, regardless of their size and the level of spillovers. RJV cartels, on the other hand, may be profitable and their profitability depends on their size. In particular, small RJV cartels are likely to be profitable whereas large RJV cartels are likely to be unprofitable. The aggregate rate of innovation with an R&D or an RJV cartel is the same as under R&D competition. However, this does not imply that profitable RJV cartels are always welfare improving. Since sharing of R&D outcomes affects the equilibrium number of firms in the product market after the R&D race, the consumer welfare effects of RJV cartels are sensitive to the specification of consumer preferences. Finally, we show that there may be a case for subsidizing cooperative R&D because some unprofitable R&D cartels and RJV cartels are welfare improving. These results extend the existing results in the literature in significant ways since in the literature, cooperative R&D arrangements are generally found to be profitable and their welfare effects depend on the level of spillovers. JEL classification: L1, L4, O3