In the last few decades, the effects of cooperative R&D arrangements on innovation and welfare have played an important role in policy making. 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, 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. We show that sharing of research outcomes is a necessary condition for the profitability of cooperative R&D arrangements with free entry. The profitability of RJV cartels depends on their size. The impact of cooperative R&D arrangements on the aggregate level of innovation depends on whether there are participants in the R&D race who are a part of the cooperative R&D arrangement. If some outsiders choose to participate in the R&D race, the aggregate rate of innovation 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 the aggregate rate of innovation to increase. In such cases, it may be desirable to subsidize them. 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. Subsidies may be desirable in cases of larger RJVs since they are the ones which are less likely to be profitable.
