Schumpeterian Tradeoffs and policy tools

Several kinds of social costs are incurred when technological progress is “purchased” through a system of economic organization that pits private business firms against one another in a struggle for competitive advantage.

One of these is the cost associated with less than competitive out­ put levels. The presence of such a cost is signaled by a gap between price and the marginal production costs in the most progressive firms. However, static inefficiencies also reside in the extent to which the “best technology” is monopolized by one firm in the in­ dustry, independent of whether that firm is large enough to have market power. Indeed, there are two different kinds of costs asso­ ciated with limits on the use of technical information imposed by the patent system or simply by industrial secrecy. One is a higher average production cost than given technological knowledge would permit, a cost associated with a gap between best practice and average practice. Another is the presence of duplicative or near­ duplicative R&D efforts, resulting in a lower best practice for a given amount of cumulative industry R&D (or more R&D needed to achieve a given best practice) . In addition, of course, there is a pos­ sible distortion of the level of total R&D effort, which may be greater or less than it would be in a hypothetical second-best optimum in which the other costs are accepted.

Setting aside for the moment the last of these considerations, the other costs can be depicted as in Figure 14. 1.2 Let C equal unit pro­ duction costs if industry R&D were spent perfectly efficiently and all firms had access to the best known technology. With a demand curve A-B, potential consumer-plus-producer surplus is triangle ABC. Let e equal unit production costs with the actual best-practice technology (given some near-duplicative R&D efforts) and the jagged line c-c’ represent an  industry production cost  schedule,  arraying costs  by firms from the most efficient (cost c) to the least efficient firm actually producing (cost c’).  Let actual output be Q¯. Actual surplus then is AP’ c’ c. The difference between actual and potenti al surplus is ac­ counted for by three areas: (1) P’ de, a conventional deadweight loss triangle associated with the o utput shortfall relative to competitive equilibrium at best-practice cost; (2) cc’e , or excess production costs due to a gap between best and average practice; (3) CcdB associated with lower best practice due to inefficient industry R&D.

Assume that costs of one or more of these forms are unavoidable if innovation is to occur in a market setting. If there are to be private incentives for innovative effort, there must be some degree of private property (at least de facto) in the fruits of such effort; practically speaking, this means that some social costs of the sorts identified above must be accepted. How should one then approach the problem of assessing the social gains from more industry R&D so as to reach some conclusion regarding the suitability of the total R&D effort that private incentives would produce? In the first place, the discussion in the two preceding chapters points out that some key determinants of the social gains are themselves endogenously determined by, or codetermined with, market structure. For example, it matters whether R&D expenditure is efficiently allocated from a social point of view, and this is partly a function of market structure. But there are also important exogenous considerations. The gains from a higher level of industry R&D spending depend partly on the tech­ nological regime that governs R&D outcomes. For exa mple, it matters whether diminishing returns to R&D effort set in early and sharply (the science-based case of the preceding chapters) , or whether marginal returns continue to be high at high levels of expenditure. In the former case, but not the latter, low levels of in­ dustry R&D expenditure may buy society much of what a signifi­ cantly higher level would.

14.1    Social  costs  of  Schumpeterian  competition .

1. Policy Issues

Assume that there is indeed a tradeoff between the industry struc­ ture that performs best, given the set of available technologies, and the structure most conducive to a dvancing technology. And assume that somehow society could agree on the nature of the tradeoff and on the target point for poHcy. Although the discussion above iden-tilies causal links between innovative opportuni ties and the market structure that evolves, it offers no reason to expect that the social tradeoff might be optimized by the automatic functioning of those links . It is quite reasonable, therefore, for economists to be inter­ ested in policies that can influence structure. But most of the studies that purport to address this issue are not very clear about what policy instruments could influence structure.

There seems to be a notion implicit in many studies that industry structure itself is the policy variable and that structure should be chosen so as to optimize the tradeoff. However, it is not clear how far the policy tools presently existing or proposed can go toward af­ fecting structure in a durable way. In particular, even if it could be argued that a lesser degree of concentration than prevails in an in­ dustry would promote more innovativeness, and would hence be de­ sirable  on  both  static  and  dynamic  grounds,  a  deconcentration achieved by policy may be undone over time as firms grow and de­ cline in the now more innovative environment. And repeated struc­ tural interventions would certainly lead to behavioral changes that might be costly in themselves .

On occasion, policy can influence structure directly if not durably, as by requiring divestitures or by forbidding or encouraging mergers or entry. But much of policy aimed at influencing industry perform­ ance operates by constraining or requiring certain behavior and af­ fects structure indirectly. In terms of the discussion above, govern­ ment policies -for example, regarding the rights and obligations of patent holders-can influence whether imitation is hard or easy. Or antitrust policy may permit firms with a large market share and a strong technological position to exploit these advantages and take a larger market share; or policy may restrain such tendencies . Policies aimed at controlling behavior influence performance directly-and also indirectly, by influencing the structure that evolves, which in turn determines performance.

Another complication of the policy task arises from the fact that structure is likely to respond rather slowly to feasible policy adjust­ ments. It is at least reasonable to propose that the time patterns of so­ cial costs and benefits ought to receive some consideration when pol­ icy measures affecting structure are analyzed. And it may be that differences among industries in terms of stage of historical develop­ ment and dynamic response to policy should be included, along with differences in the technological change regime, in the list of consid­ erations that tend to fragment the grand Schumpeterian question into a diverse set of issues relevant to narrowly defined contexts .

In sum, much of the analysis relating market structure to tech­ nological advance and static efficiency does not really connect with the policy instruments that are available. A serious analysis must probe deeper, recognizing that structure is endogenous to a regime of Schumpeterian competition, and attempt to identify the policy variables that can influence structure.

Source: Nelson Richard R., Winter Sidney G. (1985), An Evolutionary Theory of Economic Change, Belknap Press: An Imprint of Harvard University Press.

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