In Discussion Paper No. 1243, Research Affiliate Dermot Leahy and Research Fellow Peter Neary aim to establish the principles which should govern public policy towards industries where R&D is important. In particular, they disentangle the influences of strategic behaviour and R&D cooperation on the levels of output, R&D and welfare; they compare the private and social performance of different equilibria; and they calculate explicitly the optimal subsidies to R&D and output under different assumptions about strategic behaviour and the ability of firms to cooperate.

The paper considers three issues under different assumptions about the degree of strategic behaviour and cooperation. First, it attempts to provide a comprehensive ranking of output, R&D and welfare: the ranking of welfare levels is essential from a public policy perspective., and this is achieved by focusing on the incentives to engage in R&D in the various cases. Second, the paper attempts to rank industry profit levels: such ranking allows investigation of the market incentives for firms to engage in R&D cooperation without any intervention. The last objective is to consider the nature of optimal intervention. First-best optimal subsidies to R&D are higher when firms play strategically against each other, but lower when they cooperate on R&D (at least with high spillovers) and when they play strategically against the government. Second-best optimal subsidies to R&D are presumptively higher than first-best ones, but policies to encourage cooperation are likely to be redundant (since it is always privately profitable) and simulations suggest that the welfare cost of lax competition policy is high.

Public Policy Towards R&D in Oligopolistic Industries
Dermot Leahy and J Peter Neary

Discussion Paper No. 1243, October 1995 (IO)