A STRATEGIC TRADE POLICY ?

When American and European policy-makers justify their adjustment of the antitrust law in favor of research and development (R&D) cooperation among firms, they mention among other reasons their desire to provide domestic firms with an additional tool to strengthen their competitiveness. The idea is that domestic firms would achieve innovation faster and cheaper through R&D cooperation and afterward would better face foreign rival competitive pressure and gain larger market shares. The question that arises then is: Does the promotion of R&D cooperation allow to reach such a goal? This research uses the strategic trade policy approach which developed in the 80s to analyze the efficiency of R&D cooperation as an industrial-cum-trade policy tool. The decision problem of the government concerned with stimulating domestic firms’ competitiveness in presence of a foreign competitive pressure is examined in a partial equilibrium three-stage game. The objective is to determine the optimal degree, from a domestic point of view, of collaboration among domestic firms. Before firms act, the domestic government defines the extent to which domestic antitrust law allows cooperation in R&D and market collaboration after joint R&D efforts. Three alternative policies are available: to forbid any joint activity, to allow only R&D cooperation, to allow R&D cooperation and the extension of the joint efforts to production and sales. Then, given the implemented policy, the domestic firms invest in R&D in order to improve their production process and become more productive. Finally, foreign and domestic firms produce and compete for sale. The cases of Cournot and Bertrand competition (i.e., two games) are investigated and compared. The subgame perfect equilibrium analysis of these two games show that the optimal strategy for the government consists in tailoring its R&D cooperation policy according to the industry characteristics. In particular, the analysis points out that in its policy decision the government should take into account the intensity of market competition and the industry trade structure. For example, under price competition, the common wisdom policy, "to allow R&D cooperation, but to forbid market collaboration" is not optimal. The trade structure (approximated by the proportion of domestic demand in the world demand in the model) matters in the policy efficiency assessment because it determines the magnitude of the domestic welfare loss induced by collusion among domestic firms. This work confirms thus a key result of the strategic trade policy literature: the dependence of the optimal policy on the type of competition prevailing on the market. In addition, this analysis reveals that the influence of a foreign competitive pressure on profitmaximizing levels of R&D investment and on the emergence of collusive behaviors varies according to the nature of market competition. Moreover, it also draws attention to the need to assess the probability and the effects of market collusion after R&D cooperation from a global point of view, taking into consideration the existence of foreign competition and market imperfections. Finally, this study indicates that to promote R&D cooperation is not a panacea; indeed there exist in both games a parameter range for which none of the three alternatives leads to R&D investment by domestic firms. Address for Correspondence: Pauline Rutsaert Merit, Rijksuniversiteit Limburg P.O. Box 616 6200 MD Maastricht, The Netherlands TO PROMOTE R&D COOPERATION: A STRATEGIC TRADE POLICY? Section 1: Introduction For the last fifteen years, the United States of America (USA) and the European Union (EU) have been debating about the desirability of promoting R&D cooperation among firms. The background of this discussion was the existing antitrust law which considers as illegal any inter-firm collaboration likely to affect competition in a welfare-worsening way. The adjustment of the competition law toward more flexibility has been advocated by several economic and law experts. During the 80s, at least three significant achievements have come out of this debate: first, the National Cooperative Research Act (NRCA) was passed in the USA in 1984; second, the European Research Cooperative Agency (Eurêka) was created in 1985 by the joint initiative of European governments and industrialists; third, the EU voted a bloc exemption for R&D cooperation in 1987. 1 This modification of antitrust law aimed at favoring a flexible treatment of R&D cooperation agreements was based on a thorough analysis of the private and public costs and benefits of R&D cooperation. Among the other arguments used to justify such departure from a strict application of the antitrust law were the hopes and beliefs that R&D cooperation could help firms to restore and/or increase their competitiveness and enable them to better face foreign competitive pressure. The idea was that R&D cooperation is likely to lead to faster and cheaper innovations thanks to the internalization of technological spillovers, the R&D costs and risks sharing, the synergies of assets and skills, and the enhanced diffusion of innovation. However, no formal analysis -to my knowledgehas attempted to evaluate the efficiency of promoting R&D cooperation and of allowing joint exploitation of cooperative R&D outcomes taking into account foreign competitive pressure. The present research offers an efficiency assessment of this 1 The National Cooperative Research Act (NRCA) passed in the USA in 1984 explicitly specifies the legal treatment of R&D cooperation agreements according to a rule of reason and offers a possibility of registration for R&D cooperative agreements after which damages are reduced from treble to single. (See the 1990 Summer issue of the Journal of Economic Perspective for an interesting forum of experts on the state of American antitrust law vis-a-vis R&D cooperation.) The objective of the European Research Cooperative Agency (Eurêka) created in 1985 by the joint initiative of European governments and industrialists is to promote cooperative R&D projects that should lead to new, finalized, and marketable products and systems. The bloc exemption for R&D cooperation voted in 1987 by the EU confirms the European stand, namely that the legality of R&D cooperation agreements is assessed using a rule of reason (as expressed in the 1968 Notice on R&D cooperation) and extends the EU tolerance to joint exploitation of collectively achieved R&D outcomes under certain circumstances. (For more details, see Jacquemin (1988). ) antitrust-cum-trade policy aimed at encouraging R&D cooperation using an open economy framework,. In order to tackle this industrial policy problem, I follow the strategic trade policy approach that developed in the 80s after the works of Brander and Spencer. 2 As it is standard in this literature stream, I analyze the policy issue in a partial equilibrium framework using a sequential game. A three-stage game is built in which the government implements first a policy, then the domestic firms choose an R&D investment strategy, and finally the domestic and foreign firms compete for sale in the market. The cases of Cournot competition and Bertrand competition are both examined and then compared. Although the model uses specific functional forms and is solved under particular assumptions, the equilibrium outcomes confirm one of the main conclusions of the strategic trade policy theory: the efficiency of a policy -in this case, an antitrust-cum-trade policydepends on the type of competition prevailing on the market. 3 This central result -namely,the dependence of the optimal policy on trade and market featuresis expected to be preserved if certain restrictive assumptions (homogeneous good, a unique world market, symmetric domestic firms, non-strategic role of the foreign agents at the R&D and policy stages) are relaxed. However, at the same time, the use of less restrictive assumptions is likely to lead to less contrasted outcomes. The game results also point out to interesting facts relevant for antitrust and/or policy authorities. First, the structure of trade (as approximated by the proportion of domestic demand in the world demand) matters to assess the desirability of allowing market collaboration after R&D cooperation. Indeed, it determines the magnitude of the welfare loss due to collusion that is to be borne by domestic consumers. Second, the influence of foreign competition on R&D investment at equilibrium varies according to the nature of market competition. Third, the link between R&D cooperation and market collusion is examined and is revealed to be dependent on the nature of competition and on the intensity of foreign competitive pressure. Fourth, it is observed that there exist in both games and under all policy alternatives parameter ranges for which no R&D investment occurs. This highlights the fact that to promote R&D cooperation is not a panacea. 2 In the strategic trade policy approach, government’s policy choices are viewed as interventions meant to alter the economic environment in which domestic firms act. The objective is to enable firms to select actions or strategies that they could not have credibly chosen without intervention on the one hand, and that generates a rent transfer from foreign firms to domestic firms on the other hand. In other words, by a strategic trade policy, the government tries to modify domestic firms’ incentives so that their decisions lead to increased domestic welfare. See, for example, Spencer and Brander (1983). 3 See the survey by Dixit (1987)