Are Arrow’s and Schumpeter’s classical results sensitive to the intensity of competition?

What is it about?

This paper considers a theoretical model where firms reduce their initial unit costs by spending on R&D activities in a collusive market and where firms are able to coordinate on distinct output levels other than that of the unrestricted joint profit maximization outcome. We show that, in our model, the degree of collusion (captured by the discount factor) reduces the incentive to innovate when innovation is made non cooperatively. The reason is that non-cooperative R&D introduces a negative externality where firms overinvest beyond the effort required to minimize the cost in order to extract profits from the rival firm, and a reduction in product competition helps internalize the externality. In a research joint venture, the absence of R&D rivalry leads to contrary results. The main implication is that the validity of the Schumpeterian hypotheses depends on the extent of cooperation at the R&D stage.

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Why is it important?

The current paper adds to the existing literature by examining the effects on innovation of the degree of product market tacit collusion, a problem that, to the best of our knowledge, has not been extensively considered