Meet Me Halfway but don't Rush : Absorptive capacity and strategic R&D investment revisited

Abstract

In this paper, we analyse how R&D investment decisions are affected by R&D spillovers between firms, taking into consideration that more R&D investment improves the ability to learn from competing firms - the so-called absorptive capacity effect of R&D. The model in this paper is an extension of d’Aspremont and Jacquemin (1988), where they show that exogenous R&D spillovers reduce the incentive to invest in R&D when firms compete in a Cournot duopoly. Our model treats R&D spillovers as endogenous, being a function of absorptive capacity effects. Contrary to earlier studies, we show that absorptive capacity effects do not necessarily drive up the incentive to invest in R&D. This only happens when the market size is small or the absorptive capacity effect is weak. Otherwise firms will actually chose to cut down on R&D. Furthermore, absorptive capacity effects also increase the critical rate of spillovers that determines whether participating in research joint ventures leads to lower or higher R&D investment. Finally, we show that strong learning effects of own R&D are not necessarily good for welfare. Moreover, if the market size is large, welfare will be at its highest when the learning effect is small.