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

We study a dynamic duopoly model of R\&D to analyze the impact of imperfect appropriability on market structure and welfare. We pursue this analysis by extending the Markov-Perfect dynamic industry model proposed by Ericson and Pakes (EP) (1995), through the introduction of a non-proprietary productivity component to R\&D as part of a dynamic, stochastic process. We find that when spillovers are costless, or that when firms can absorb spillovers by investing in imitative R\&D, the impact of the extent of spillovers on concentration levels is negligible. However, when.spillovers require absorptive capacity investment in own R\&D, concentration levels decline with increases in the extent of spillovers and welfare improves. The difference lies in the degree of substitutability between own and external R\&D sources. When own and external R\&D are perfect or nearly perfect substitutes, the rates of innovation and hence the market structures are unaffected. When spillovers can only be obtained through absorptive R\&D, the degree of substitutability falls, leading to higher rates of innovation, particularly by smaller firms,and a less concentrated market structure.