The Competitiveness of Nations in a Global Knowledge-Based Economy
Partha Dasgupta
* [1]
The
Welfare Economics of Knowledge Production
Oxford
Review of Economic Policy, 4 (4,) 1988
Content
II
- Knowledge-Producing Institutions: An Argument by Design
i) The Samuelsonian Contrivance
iii)
The Lindahl Market Mechanis
III
- Basic and Applied Research
IV
- Efficient Property Rights
HHC: Index and page numbers added
Carl Christian von
Weizsäcker begins his excellent book on entry barriers by classifying
economic activity into three classes, or levels as he calls them: the exchange
of goods, the production of material commodities, and the creation of knowledge. (See von Weizsäcker, 1980.) He is prompted into developing this
classification, rather than some other, because these three levels are on the
whole easy to distinguish, and because they are in an order of increasing
distance from the consumption of material goods and services. Von Weizsäcker in
fact proceeds to demonstrate in his book that this distance has a marked
influence on the organization of the economic activity in question
Von Weizsäcker’s
classification is time honoured. But until recently much of the focus of
analytical economics had been on the first two levels: those of exchange and
production of material goods and services. The analytical economics of knowledge had been
on the whole an impoverished sibling. All
this has changed over the past decade or so, and the microeconomic analysis of
technological change is an active field of research. But as in all other types of enquiry it would
appear rapidly to have acquired an internal history. A number of the early papers in the field (e.g.
Kamien and Schwartz, 1978; Levin, 1978; Loury, 1979; Dasgupta and Stiglitz, 1980a, b) analysed
the characteristics of strategic behaviour on the part
of profit-maximizing firms when they compete not only in the production of goods
and services, but also in the development of new products and new ways of
manufacturing old products; what one would want to call technological
competition. Now, for reasons that are
well understood today, the theory of perfect competition is of no use here. [2] Even if
technological competition were fierce, the resulting industrial structure would
be oligopolistic, as the recent literature on these matters has
made clear. Moreover, in order to
understand the structure of industries we must trace back to the possibilities
facing inventors and developers, to their underlying motivation, and to the
background
* University
of Cambridge
1.
Over the years I have gained much from discussions on the matters covered in
this essay with Paul David, Eric Maskin, and Joseph Stiglitz, with each of whom I have collaborated on several
occasions. The material in Section H is
based largely on Dasgupta and David (1988), which
also develops a thesis concerning the historical origins of science and technology
as social institutions In writing this essay I have also
benefited greatly from the instructions that John Vickers has given me
2. See Schumpeter (1976) for
an early elaboration of this viewpoint.
1
incentive structure. The recent literature on the microeconomics of
technological change has clarified a number of these issues. Nevertheless, it is unfortunate that the
literature has been dominated by matters concerning patent races, at the
expense of pretty much all else.
In this essay I want to redress the balance, even if
only by tiny bit, and talk of other matters. Specifically I want to study the sorts of
social institutions which can, at least in principle, sustain an efficient
leve1 of inventive and innovative activity. Plainly, the characteristics of such
institutions will depend upon the nature of the produced commodity in question,
namely knowledge. It is best then to
start with that
II - Knowledge-Producing
Institutions: An Argument by Design
Knowledge is not a homogeneous commodity. There are different kinds of knowledge and no
obvious natural units in which they can be measured. Indeed, each piece of knowledge is a separate
commodity. It is indivisible, in the
sense that once a certain piece of knowledge has been acquired there is no
value to acquiring it again: the wheel does not need to be invented twice. The same piece of information call be used over and over again, at no cost (Marx, 1970; Arrow,
1962). For my purpose here it does not
matter whether we think that certain kinds of knowledge possess intrinsic worth
in the Aristotelian sense, or whether we value knowledge solely in functional
terms. [3] What
is of critical importance is that knowledge and more specifically information,
can be jointly consumed and used by as many as care to. Thus, if one person gives another person a
piece of information this does not reduce the amount of information held by the
first possessor, although of course the benefit to each typically will depend
upon whether and in what manner the other makes use of this piece of knowledge.
In short, knowledge has the hallmark of
a public good, a durable public good.
In what follows I shall for simplicity of exposition
assume that the cost at transmitting knowledge is negligible when compared to
its production cost. This is not as wild
an assumption as it might appear at first blush, especially today, because
transmission costs are to be distinguished from the costs incurred in educating
people to interpret the knowledge and to make use of it. This latter is what one would call the cost of
education of learning, of absorption, of processing and so forth. Plainly the greater the number of people who
can make use of transmitted knowledge the greater is the social value of that
knowledge. [4] Plainly
also, not all knowledge can be communicated, especially problem-solving skills,
more generally knowledge that is acquired
through practice on the part of the researcher.
I am not considering this kind of knowledge here for they are embodied
in the researcher. We would call such
knowledge the researcher’s skill or acquired ability. Models of learning (by doing) with the incomplete
spillover capture this kind of person-specific knowledge. (See Dasgupta and Stightz 1988)
Given this, one seeks to identify resource allocation
mechanisms, more grandly socio-economic institutions, which can in principle produce and allocate knowledge in an efficient
manner. The qualification should be
noted. As in all theories of institutional
design, I am here interested in a thought-experiment. So I assume that it is possible costlessly to design and establish an entire socio-economic
institution, supporting it with a background of attendant rules, norms, rights,
and backing them with the force of the
3. In the context of
education policy such a distinction matters greatly, and the education literature
has consistently displayed a tension between these two aspects, most especially
in debates over the choice of course curricula. This tension has on occasion been diffused, as
in the writings of John Dewey, who in his philosophy tried to fuse the two by appealing
to a sort of Aristotelian view of the development of a person. Nevertheless, the tension is a real one. But for the most part this distinction does not
affect the arguments in this essay.
4. Throughout, I am thinking
of knowledge as a ‘good’, unlike pollution. Thus I am ignoring the kinds of knowledge that
are used for purposes of waging war. This
would involve a different set of considerations regarding public policy.
law. As
it happens, modern resource-allocation theory suggests that there are three
possible institutions. As it also happens
there are analogues of each in the world as we know it I shall elaborate upon
them in turn.
i) The Samuelsonian
Contrivance
The first consists in the government engaging itself
directly in the production of knowledge allowing free use of it (recall that
transmission costs are assumed negligible) and financing the production cost
from general taxation. This was at the
heart of Professor Samuelson’s classic analysis of the efficient production and
allocation of public goods (Samuelson, 1954) [5] Government research and
development (R & D) laboratories which publicly disclose their findings
such as for example agricultural research establishments, are an approximation
of such an arrangement. It is as well to
note that the volume of public expenditure for the production of knowledge and
the allocation of this expenditure for different kinds of knowledge are in this institutional set-up public decisions.
The second resource-allocation mechanism which in
principle can produce knowledge in an efficient manner is one where production
is undertaken by private agents, who in turn are subsidized for their effort by
the public purse. Thus, the subsidies
are financed by general taxation. A
crucial feature of this arrangement is that private producers are denied exclusive
rights to the knowledge they produce.
Once knowledge is produced under this arrangement it is freely available
to all. This is the Pigovian
solution to the problem posed by public goods, and more generally, by
externalities (see Pigou, 1932; Baumol
and Oates, 1975; Dasgupta and Heal, 1979). In albeit imperfect forms this arrangement
characterizes much research in public entities, such as state funded
universities, where a good deal of the research output is prohibited from being
patented, and where salaries and promotions - the production subsidies - are
paid out of public funds.
These two resource allocation mechanisms resemble one
another greatly, but there are important differences, at least in theory. I am thinking of the Pigovian
solution as a decentralized mechanism, one where production decisions are made
by private agents, and whose work is subsidized by the government. (The subsidies are the shadow costs of
production.) And I am characterising the Samuelsonian
solution as a command mode of planning: the decision of what to produce and how
much to produce is made by the government. Of course, where the second fundamental
theorem of welfare economics holds there is no serious difference in the implementability of these two resource allocation
mechanisms. Nevertheless, they represent
different methods of planning.
iii) The Lindahl
Market Mechanism
Each of these institutions reflects a non-market
mechanism for resource allocation. The
third and final institution to consider is therefore the market mechanism
itself. Admittedly, we are discussing
the production of a public good, a commodity which can be consumed jointly. But this does not mean that private
appropriation of benefits is necessarily impossible. For some types of knowledge, what one might call
the output of basic research (see Section III), private appropriation may prove
difficult. For other types it may to a
large extent be possible. I want to
think now of those sorts of knowledge to which private ownership can be legally
assigned and whose ownership can be enforced. By ownership I mean the right to control the
use of the public good. Suppose then
that society grants producers of new knowledge
5. The social cost-benefit
rule, it will be recalled, is the equality of the marginal rate of
transformation between the public good and a numeraire
private good and the sum of the private marginal rates of indifferent
substitution between these two goods.
3
property rights to discoveries and inventions,
and allows them to engage in trade should they wish to, vja
licensing or outright sale. In the world
as we know it, patents, trademarks, and copyrights are an embodiment of such
ownership.
Clearly, the value of a given piece of knowledge is different for different people. Therefore, if production under the market mechanism is to be efficient the owner must set different prices for different buyers, since efficiency demands that the marginal cost of production of this knowledge equals the sum of the fees charged by the producer to all buyers. At an efficient market equilibrium the quantity demanded by each buyer equals the total amount which is produced and is on offer. This was Lindahl’s proposal for the supply of public goods; to establish a competitive market mechanism for it. (See Musgrave and Peacock, 1968.)
One problem with the suggestion, as Arrow (197 1)
noted, is this. Since Lindahl prices are ‘named’ prices, one for each buyer, each
of the Lindahl markets for a given piece of knowledge
is thin, essentially a bilateral monopoly. This is scarcely a propitious environment for the
emergence of efficiency prices. Furthermore,
the enforcement of property rights is difficult, particularly on the output of
fundamental research, for the findings of such research have possible applications
in wide varieties of fields, and it can be exceptionally difficult to detect a
violation of property rights. In other
words, the economic benefits of knowledge are often difficult to appropriate
privately and therefore to market efficiently. This is so even when patent and copyright
protection gives one transferable legal rights to exclude others from using
that knowledge. Matters are easier in
the case of more narrowly restricted knowledge of new technical processes and practical
devices. This partly explains why it is
a commonplace today to see A paying B a licence fee for using B’s patent on the manufacture of a
new product, or on a new process for manufacturing an old product. [6]
There is in fact an additional difficulty in applying Lindahl’s theory of public goods directly to the case of
knowledge. As we noted earlier each
piece of knowledge is a distinct entity. Producing the same piece of knowledge more
than once is of no use. [7] Different
pieces of knowledge differ from one another in their detailed characteristics,
and each piece can be thought of as a unit of the commodity with that
characteristic. We are then in the realm
of product differentiation, and unless strong assumptions are made, such as for
example that the space of product characteristics is closed and bounded we
cannot in general ensure that competitive equilibria
with full appropriability is efficient. [8] The point is a
familiar one, that firms can locate themselves in the ‘neighbourhood’
of other firms in terms of the characteristics of the knowledge they produce,
or more accurately, the characteristics of the research programmes
they pursue. We would then expect that
firms face downward-sloping demand curves in the market for knowledge, even in
a large economy unless, of course, fairly strong assumptions are made regarding
the potential size of firms. I conclude
that on a-priori grounds there are inefficiencies associated with the
market mechanism, even when appropriability poses no
problems. [9]
But this is only one side of the ledger. The other side is the fact that if they are to
function well the two non-market mechanisms we noted earlier require an
enormous quantity of centralized information, not only about private demand for
knowledge but also about research possibilities open to individuals and
6. Private firms often do not
rely on patents which involves disclosure of their
discoveries and they rely instead on secrecy. This involves a different
type of risk, in that a rival may at a future date discover the same thing and
exploit it with the backing of a patent. I am ignoring the practice of secrecy here
only because I am considering Lindahi markets, which
by definition cannot be established if firms keep their discoveries secret.
7. By this I don’t of course
mean that repeating an experiment to confirm one’s own or others’ findings is useless.
That is a different matter altogether
8. Even in a large economy. For an analysis of the efficiency properties
of monopolistic competitive industries, see e.g., Hart (1979)
9. There are a number of
other problems with this mechanism in the market for knowledge. I do not go into them here. But see Dasgupta
(1988)
firms. This tension, induced by the fact that the market mechanism and each of the various non-market planning mechanisms suffers from different types of weaknesses, has been a pervasive feature of the literature on science and technology policy.
As noted earlier each of the three allocation mechanisms
we have outlined is to be found in economies as we know. They have developed over a long period,
traceable in the European context at least, to the Renaissance patronage
system. (For a
development of this historical thesis, see Dasgupta
and David, 1988.) They work in
imperfect ways, as the foregoing discussion predicts they would, but they try
and capture the essential features of the idealised
social constructs. They have not risen
and grown out of pure design, they have instead evolved over several hundred
years. [10] Nevertheless,
it is a useful exercise to study the argument by design, as we have done. It makes clear the central features of the
organizations that have evolved over time, and are to be found today. Moreover, the fact that they co-exist requires
explanation, and the argument by design gives us a lead as to why they do; why
in fact we do not see the dominance of one of them. It has to do with differing characteristics of
different kinds of knowledge. [11]
I argue this next.
III - Basic and Applied Research
The analysis of Section II suggests that von Weizsäcker’s three-level classification of economic
activity is too coarse. One would want
to classify knowledge into types to see whether there is at least a tendency
for the market and non-market mechanisms to produce specific types. As it happens there is a classification which
is of use for this purpose: basic and applied knowledge. In his classic article, Arrow (1962), thought of: basic research as that kind of activity, the
output of which is used only as an informational input into other inventive
activities. By way of contrast, applied
research is the kind of activity whose informational output is an input in the
production of commodities - von Weizsäcker’s
intermediate level.
There are, of course, other classification schemes that
are similar in spirit, though some are misleading. Thus it is a commonplace to think of science
as being concerned with basic research and technology with applied research. On occasion one distinguishes abstract from
concrete knowledge, and on other occasions the search
for principles from the seeking of applications. And so forth. It would be out of place here to discuss
connections between these classification schemes. The basic-applied research distinction is adequate
enough for my purposes.
The distinction is an analytical one and in actual
practice it is not clear cut. Moreover,
the intention of a researcher is often quite different from his actual
performance. Much basic knowledge has
been acquired as an accidental outcome of what is applied research. For example, the immediate motivation behind Pasteur’s
research around 1870 was to solve certain practical problems connected with
fermentation in the local wine industry. He was successful in this. But the by-product of his research is what made
him immortal. The history of science and
technology is littered with instances of this.
These are happy accidents, a bonus as it were, and
although they are not rare, the immediate target of the researcher is in such
cases the solution to an applied problem. The fact that there are happy accidents does
10. For example, the first
systematic use of patents began in Venice in 1474, when the Republic promised privileges
of ten years to inventors of new arts and machines. The rule of priority in science was
institutionalized in the seventeenth century, with the rise of parliaments of
scientists, specifically the Royal Society of England (1662).
11. In an early discussion
the late Michael Polanyi, (Polanyi,
1943-4), suggested that the patent system should be abolished, that it should
be replaced by a system where inventors are rewarded out of public funds and
that potential users should have unrestricted access to the inventions. Polanyi was thus
arguing (by design) that an imperfect Pigovian
solution is superior to an imperfect Lindahl
solution.
5
not rule out the desirability of conducting
basic research, that is, where the goal itself is basic knowledge. In his oft-cited essay Arrow (1962) advanced
the argument that the more basic the character of the research the more in need
it is of public funding. He argued this
from two observations. First, the
intended output of basic research (we are calling it basic knowledge) is more
difficult to appropriate than applied knowledge (which is to be taken to mean
knowledge applicable directly to the production of material commodities). We have already touched upon this.
The second observation is more controversial. Arrow argued that the value of basic research
is more conjectural than that of applied research and is therefore more likely
to be undervalued by private individuals and firms. The idea here is that private firms and
individuals are likely to be more risk averse than they would be if acting
collectively through the government, and so may avoid undertaking basic
research to any large extent because of its greater uncertainty. A related idea is that basic research involves
on average a longer gestation lag than applied research. If private rates of discount exceed social
rates, either because of myopia or because of imperfect capital markets, there
is a case for the provision of public assistance to basic research.
These arguments have had an influence on public policy
towards basic research, both in Western Europe and in the United States. [12] While the share of basic
research expenditure incurred by the Federal Government in the United States
has been declining in recent years, it is still about two-thirds of the total. (See National Science Foundation, 1986.) In a recent interesting essay Rosenberg (1988)
provides evidence to indicate that these arguments are also correct. For example, he notes that the most successful
basic research laboratories in the private sector have been in firms that have
strong market positions, such as Bell Labs., IBM, Dupont, Dow Chemical, Eastman
Kodak, etc. Being large and enduring
they can absorb risk and take the long view. Their research success has been to a large
extent due to the close intellectual proximity maintained between the basic
research laboratories and the development and production wings of these firms.
It was noted earlier that even though the transmission
cost of knowledge may below, the cost of absorbing the information, of
interpreting it and using it fruitfully may well be very high. This is often the case with research output at
the frontiers of science and technology. Firms wishing to make use of the latest
findings that are publicly available need to have scientists who can make it
possible for them to do so. A good
portion of the ‘technology’ of their being able to do so consists in their
pursuing basic research! This provides
one reason why private firms conduct basic research. [13]
All this is to see basic knowledge as an accidental
outcome of applied research, or as being tied to applied research. In fact, of course, many of the most creative
leaps that humankind has made have been made by thinkers chasing an
intellectual problem thrown up internally by their subjects of specialization. If one had asked the late Professor Paul Dirac what he was doing when attempting to write down the
relativistic quantum field equation for the electron, he would have answered
that he was attempting just that. The
avenues along which basic knowledge grows are many and varied, and typically
unpredictable. It is for this reason one
hears the argument that a part of the public subsidy for research ought to be
earmarked for creative persons rather than projects. Creative people can be relied upon to choose
promising problems. That is what makes
them creative. One reason behind the
astonishing success of the Cavendish Laboratory at Cambridge immediately after
the Second World War was that its then Director
pursued this policy.
The direction which these considerations point at then
is this. Centralized information about
promising
12. See Mowery (1983) for a
good discussion of the influence these arguments have had on public policy
towards basic research in the United States.
13. A related reason is the
large demand of governments for equipment connected with warfare. Private firms conduct basic research in these
fields so as to be able to compete against one another for government
contracts.
avenues of research, both applied and basic, is by the nature
of things necessarily sparse. Such
diverse and specialized knowledge is dispersed among professionals in their
fields; scientists, technologists, market analysts, and so on. R & D decisions have to be decentralized. For reasons that we have explored, much basic
research needs to be funded publicly, along Pigovian
lines, where persons and teams are funded but where the choice of research programmes and strategies are left to the researchers
themselves. Of course, the detailed
organization of decisions that ought to be established is a complex matter, as
current discussion on the subject in the United Kingdom shows. Here I have for obvious reasons been painting
the organizational structures in broad strokes, in terms of prototypes
The matter is different for applied research. Appropriability of
applied knowledge is easier. Moreover, a
good deal of applied research addresses the development of products and
manufacturing processes, involving less in the way of an advancement of one’s
understanding of basic principles. There
is then a supposition that on average applied research, as we have defined it
here, is intellectually less enticing. Thus
for example the oft-made claim that many scientists hanker after knowledge for
its own sake is one made about those who are attracted to basic research. For these reasons as well there is an a-priori case for relying in the main on
the private sector for applied research by instituting intellectual property
rights, such as patents, copyrights, and trademarks. [14] There is then the
question of efficient property rights and the desirability of preventing
excessive duplication of R& D in the private sector. In the next two sections I go into these
issues.
IV - Efficient Property Rights
At first blush the structure of efficient property
rights is obvious. The Arrow-Debreu theory tells us that if it is costless to establish
markets, each and every commodity ought to be supported by a competitive market
in a private ownership economy. There is
then an immediate problem in using the theory when knowledge is treated as a
commodity. [15] For
suppose that given any knowledge base there are constant returns to scale in
the production of commodities. Since R
& D involves the expenditure of resources, production of commodities,
including knowledge, must involve increasing returns to scale. Thus in particular firms must be allowed to
earn profits from their production activities in order to recoup their R &
D expenditure. Patents are designed to
allow that to happen, to prevent competition in the producer market. But the problem is that it is not clear what a
patent means.
We noted in Section II that the right way to think of
the production of knowledge is to think about the economics of product
differentiation. Inventions and
discoveries differ by way of the characteristics of the information associated
with them. A statement made with 95 per cent confidence is different from
what is verbally the same statement made with 90 per cent confidence. Not by much perhaps, but they are by no means
the same. A patent provides a protected
sphere around the characteristics of the invention made by the patent holder. We should therefore be interested not only in
the optimal duration of patents, but we should also be interested in the
optimal tightness of patents, or in other words, the size of the
protected sphere. In addressing this
question I shall elaborate upon an argument put to me by Professor Carl Shapiro
of Princeton University.
14. It should be noted that
English and American patent laws, as forerunners of modern patent laws elsewhere,
expressly forbade patenting a ‘fact of nature’. The problem is that it is not clear what is a fact of nature. This
was illustrated recently in the litigation over the Stanford University and the
University ofCalifomia at Berkeley patcnts on recomhinant DNA. Under United States Law, a patent can be
awarded to cover ‘.., any new and useful process, machine, manufacture, or
composition of matter, or any new and useful improvement thereof. The duration of a U.S. patent is 17 years from
the date of issue.
15. I am ignoring oft-cited
problems connected with the fact that research often throws up unthought of possibilities, more specifically surprise
events, so that the information partition not only becomes finer with
discoveries, it contains elements not included previously. These issues are pertinent not only to the
Arrow-Debreu theory but to decision theory in
particular and economics in general.
7
Purely for the sake of expositional ease I suppose that
knowledge characteristics can be aggregated adequately into a scaler number. We
then have a natural metric, providing us with a distance measure between any
two pieces of information. Without loss
of generality I suppose that the state of knowledge at the initial date (t=O)
is zero. For simplicity I assume that
the cost of producing knowledge of measure y (y≥0) is k(y). (This cost can be thought of as being the
expenditure of a numeraire commodity, say income.) The greater the extent of the invention, the
greater is the cost. Thus
k’(y) ≥ 0. [16] We
may think of y as the extent of a cost reducing invention, or an index of the
quality improvement of an existing product.
Denote by x the size of the protected sphere around the
discovery. The interpretation is that
when a discovery is made the discoverer is protected from entry by rivals into
the region consisting of points within a distance x from the discovery, y. (It should be remembered that when the
discoverer of y announces it rivals can, unless prevented by law, make use of y
without having to incur k(y).) Let T be
the duration of this protection, the patent length. Let B(x, y) denote the flow of social benefits
and P(x, y) the flow of private profits to the discoverer. Making standard assumptions we would conclude
that Bx(x, y)
< 0, By(x, y) >0, Px(x,
y)> 0, Py(x,y) >0, and P(0,y)= 0 for all y. In what follows I ignore income effects. The government is to choose x, y and T with a
view to maximising the present value of social
benefits, subject to the constraint that the present value of profits earned by
the inventor is non-negative. [17] Let r (>0) be the
social rate of discount, assumed without loss of generality to be equal to the
discount rate of the private sector. It
follows that the government’s problem is: Choose x (≥0), y (≥0) and
T (≥0) so as to maximise
(1)
Subject to the constraint
To have a non-trivial problem suppose that it is
socially beneficial to have some discovery. It is then a trivial matter to confirm that
the optimal values of x and y satisfy the pair of conditions
P(x,y)
= rk(y) (2)
and
Px(x, y) [By(x,
y) - rk.’(y)]=
Bx(x, y) [Py(x, y) - rk’(y)];
(3)
and that theoptimal
value of T is infinity. In other words, the
patent issued should be a permanent one, but the protected sphere defining the
patent on y should be of the smallest size consistent with the researcher being
willing to undertake the research (condition [2]). Putting it slightly differently, the
intellectual property should be a free-hold, but the property should be defined
as narrowly as is compatible with incentives on the part of the private sector
to produce the property.
An immediate implication of conditions (2) and (3) is
that the size of the optimum protected sphere is not invariant to the kind of
discovery we are studying. This follows
at once from the fact that both the social benefit function,
B, and the private profit function, P, depend upon the type of knowledge
production we are considering. What is
invariant is the optimum length of the patent. This invariance result should be contrasted
with the results in Nordhaus (1969), Dasgupta and Stiglitz (1980b), Stoneman (1987) and Dasgupta
(1987), which argue that the optimum patent length is finite and that it is
dependent upon the type of discovery being studied. I shall presently try and explain why we are
obtaining such strikingly different results.
16.
As usual, for simplicity of exposition I assume that the discovery is made
instantaneously. I ignore uncertainty in
the R & D process since this will raise additional matters. For an analysis of this last see Dasgupta (1987). See
also Section V.
17. Thus, the government is a
Stackleberg leader. I suppose for simplicity of exposition that
competition among potential inventors leads in equilibrium to a single agent
carrying out the R & D at a pace which the government can choose so long as
it does not yield negative present value profits.
Why
do
we not see the policy implied by (1) put into practice? There are several reasons. Here I want to concentrate on one which brings
out quite sharply a feature of knowledge production which is not captured in
(1). It has to do with private learning
and it carries with it the implication that the solution of (1) is not implementable in short, it is inconsistent with incentives.
Let x* and y* denote the solution to (1). By hypothesis, the initial state of knowledge
is zero. (This, as we noted, is merely a normalization,
of no significance.) But
y*>0. Thus the optimum
solution envisages a discrete change in the state variable, namely the state of
knowledge. Consider the agent who has
made the discovery. Assume for the
moment that the agent does not disclose his finding. Thus, the state of knowledge of this agent is
y*, that of all others is still nil. But now the cost of discovering all pieces of
knowledge in the neighbourhood of y* is tiny for the
agent in question and is approximately k(y*) for each of the others. The
knowledgeable person has a great advantage over the rest. So then when the discoverer applies for a patent
he will seek a patent not only on y*,but on all pieces
of knowledge in the neighbourhood of y*, the size of
the neighbourhood depending upon how easy it is for
the discoverer to scan around the discovery y*. In general when this learning effect is large,
the neighbourhood the discoverer can scan pretty much
costlessly exceeds x*. One concludes that when a discoverer applies
for a patent he applies for a patent on an entire region in the space of
knowledge characteristics. It follows
that in general x* is not implementable: the
protected sphere cannot be made as small as the government might ideally
like. From this it follows at once that
the optimum patent length is finite. [18]
Research projects have uncertain yields. No one who launches a programme
of research can be certain of the outcome. Each project possesses an irreducible element
which is specific to the team conducting it which is another way of saying that
in characterizing a project one must include the minds that are directing and
conducting it. Thus, apart of the
uncertainty concerning output is what one might call ‘team-specific’. It follows from this that the uncertainties
faced by two research teams can never be fully and positively correlated. [19] They would not be
fully and positively correlated even if, acting as separate teams, they were to
pursue what is otherwise the same programme of
research.
It can be argued that private firms competing for a
patent pursue overly correlated projects (Dasgupta
and Maskin1987). This they tend to do
even when they are neutral to risk. The intuition
behind this result makes clearer the effect of the institution of patents on R
& D races. As we noted earlier,
patents aim at awarding all private profits to the winner of the race, the more
comprehensive a patent the greater is the flow of profits to the winner. If a firm were to choose a research project
which is less correlated with the project chosen by its rival, it would bestow
a positive externality on the rival. Specifically,
the likelihood that the rival is successful when the firm in question is not, would increase. This
is socially desirable (because cet. par. society does not care who wins the
patent, so long as a good discovery is made), but it is not picked up in the
firm’s private calculation. As our intuitions
about externalities would suggest, this means that there is excessive
similarity among the research projects pursued by private firms engaged in a
patent race.
18. Nordhaus
(1969) and Stoneman (1987) explored the optimum
lengths of patents when, as in (1) above, the R & D process involves no
uncertainty. This enabled them to
postulate that in equilibrium there is a single agent engaged in R & D. Dasgupta and Stiglitz (1980b) explored some of the additional problems
that arise if firms face independent uncertainties regarding their R & D
technologies. In equilibrium the number
of firms in this sort of situation is not unity and one has to correct for the
fact that the number of active firms is also affected by the patent length. The result in Dasgupta
and Stiglitz (1980b) concerning the length of optimum
patents is valid only if the patent holder is a perfectly discriminating
monopolist. Dasgupta
(1987) corrects the erroneous statement in the earlier paper that it does not
depend upon this assumption.
19.
They can, of course, be fully and negatively correlated if they are involved
in, say, testing mutually exclusive hypotheses.
9
Entry into patent races can be a cause of waste. If entry is relatively costless there can be
a dissipation of expected rents from inventions, as firms chase an invention
knowing that there is some chance of winning the patent. It is possible to show that under a wide class
of cases, patent competition results in firms pursuing an excessive number of
parallel research projects. (Loury,
1979; Dasgupta and Stiglitz,
1980a, b.) This is another way of saying that the
market can sustain excessive duplication. [20]
This is a special kind of market failure, and it is not
easy to see how it can be corrected for by R & D taxes. In order to impose such corrective taxes the
government needs to be able to monitor a firm’s R & D programme
in specific details. (How else is the
government to judge that it has chosen an overly duplicative programme?) This the firm rightly will not wish to allow, because this
would disclose information and would dilute the firm’s prospects of
appropriating the benefits from its R & D effort. The discussion of Section II is relevant
again. Disclosure (of one’s R & D
project) dilutes the incentives for undertaking R & D in the first place. One concludes that the prescription of an
externality tax is incompatible with incentives.
I would argue that these possibilities on their own
provide some justification for the encouragement of joint R & D ventures
among private firms. They are different
from the argument that is most often put forward in popular writings, that
joint ventures enable firms to pool their R & D risks and thereby enable
them to undertake projects which otherwise would not be undertaken. [21]
The distinction between basic and applied research is
somewhat blurred in a joint venture, for the reason that such programmes are highly targeted towards commercial goals. But in principle one can ask about the
appropriate mix of co-operation and competition, even at the R & D stage. For example, one can imagine firms cooperating
in basic research; that is, pooling their research laboratories and sharing the
output of basic research, and then competing at the development stage once the
basic research is completed. On the
other hand, one often sees in practice an agreement to share the costs and
output of R & D (both basic and developmental), to be followed by
competition in commodity production. Then
there are examples, such as EUREKA, where the venture is joint
all the way from research and development to the product market, what I shall
call a vertically integrated joint venture.
In a closed economy an analysis of a vertically
integrated joint venture may seem in effect an analysis of pure monopoly. But this would not be correct. When firms enter a joint venture they do not
become a single firm. Their R & D
laboratories will co-operate but they will not become a single laboratory. This makes the analysis of joint ventures
difficult even when they are vertically integrated. Nevertheless, many of the ingredients of any
such analysis are embedded in the discussions of Sections II and III.
Within joint ventures a distinction should be made
between two polar cases: (i) those where the venture
not only allows firms to co-ordinate their policies, it also commits them to
share their newly discovered knowledge; and (ii) those where the only gain is a
co-ordination of policies. The key
feature underlying (ii) is that the extent to which knowledge is shared is not
subject to control: a certain ‘fraction’ of each firm’s R & D output spills
over to the rival firm whether or not they agree on a joint venture. The distinction therefore is based on the
extent to which the firms’ R & D laboratories are combined by the venture. Underlying (i) is
the assumption that the laboratory outputs are common property. Underlying (ii) is the hypothesis that they are
kept separate, but that their funding is determined by a joint policy.
20.
We emphasise the use of the term ‘excessive’ because
it is often desirable socially to have several parallel research projects in
operation, just as it is desirable to hold a diversified financial portfolio.
21.
Within the European Economic Community members are engaged in large scale
operations, such as RACE (Research in Advanced Telecommunication Technology for
Europe Programme). EUREKA (European Research Coordination Agency:
ESPRIT (European Strategic Programme for R & D in
Information Technologies); and in the United States by MCC (Microelectronics
and Computer Technology Corporation).
Our earlier discussion is directly applicable to (i) and in fact it is (i) which is
most often alluded to in the literature. A central gain, both to the firms involved and
to society, is the sharing of knowledge. As against this is a possible loss to society
occasioned by the fact that a joint venture implies greater monopoly
power. The gain from shared knowledge is
absent from (ii), because by hypothesis the extent to which knowledge is made
common is unaffected by the venture, although of course the amount of knowledge
each firm produces is affected. [22]
In a recent interesting note d’Aspremont and Jacquemin (1987) have analysed the implications of joint ventures with (ii) as the background situation. There is no uncertainty postulated, R & D is directed at process innovations and the R & D technology is assumed to enjoy no scale economies. It is supposed that a certain amount of knowledge spills across the firms’ R & D laboratories in an exogenous manner. (This last is what makes the venture one of pure co-ordination case [ii])
Knowledge spillovers are a form of positive externality. So it might be thought that a joint venture
must necessarily involve greater R & D expenditure: the venture after all internalizes
the externality. But this would be wrong.
The point is that if the joint venture
were to be restricted to a co-ordination of R & D expenditure, the firms
would expect to compete in the product market once R & D were
completed. The firms would know in
advance that after the completion of R & D there will be no jointly agreed
production policy. Given this, they may
well choose to agree on a lower R & D expenditure level, lower than, that
is, the level that would emerge it they were not to have a joint venture
Clearly then the answer depends upon the extent of knowledge spillover.
If this is large a joint R & D venture
would be expected to result in greater R & D expenditure and indeed even
greater output production. This can be
shown to be the case. (See d’Aspremont and Jacquemm, 1987) In
fact it can be shown that if knowledge spillovers are large a vertically integrated
joint venture would be expected to sustain even greater R & D expenditure
than a mere R & D joint venture. Where a vertically integrated joint venture is
restrictive is at the production stage, and consumers can end up paying a
higher product price even though production costs are lower because of the
integrated nature of the venture. The
greater surplus is captured by what is in effect a monopolist and distributed
to shareholders. A joint venture,
whether restricted to the R & D stage or whether integrated fully, does not
produce the first-best efficient outcome. But if spillovers are large an R & D joint
venture can be closer to it than unbridled competition.
These results are congenial to intuition. They also indicate that our broad brush
discussion of the welfare economics of knowledge production has probably been
along the right lines. The tension we
noted earlier in this essay, between the need for co-ordination and sharing of
produced knowledge the paucity of centralized information about R & D possibilities
and dilution of private incentives to produce knowledge if it is to be shared, is at the heart of the basis upon which public
policy has to be geared.
22.
A good deal of the urgency expressed within the EEC and the USA about having
joint ventures in R & D, especially in high technology industries, is the
competitive threat from Japan. In the
text I shall ignore such gains from joint ventures and ask whether there are
gains to a society in having R & D ventures even if it were to face
no competitive threat from outside.
11
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12