The Impact of Cost-Reducing R&D Spillovers on the Ergodic Distribution of Market Structures

We extend the literature on knowledge spillovers between firms by studying a dynamic duopoly model of R&D. Our analysis highlights the previously ignored welfare effects of spillovers through dynamic changes in industry concentration. In addition, we find that the impact of imperfect appropriability of R&D on concentration and welfare depends crucially on the manner in which spillovers are obtained. To date, the analysis of the impact of knowledge spillovers between firms has been largely restricted to static two-stage models (R&D decisions followed by product market decisions). These models generally predict suboptimal R&D expenditures and lower welfare. Such models are silent on the evolution of the market structure, and the resulting welfare implications, because they need to assume initial conditions (symmetry or asymmetry). We find that when spillovers require absorptive capacity investment in own R&D, larger spillovers lead to declines in concentration while rates of innovation increase and welfare rises. In contrast, when spillovers are costlessly obtained increases in the extent of spillovers rates of innovation fall leading to losses in welfare through both reduced consumer surplus and firm values, while the effect on concentration is ambiguous.