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R&D Investment and Output Competition by Supply-Managed Producer Associations. Zoe Campbell James Vercammen University of British Columbia CAES/AAEA Annual Meetings Portland (July 30, 2007). Producer-Funded R&D.

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r d investment and output competition by supply managed producer associations

R&D Investment and Output Competition by Supply-Managed Producer Associations

Zoe Campbell

James Vercammen

University of British Columbia

CAES/AAEA Annual Meetings

Portland (July 30, 2007)

producer funded r d
Producer-Funded R&D
  • Public sector agricultural R&D is gradually being replaced by private sector R&D in many countries (Alston, Pardey, and Roseboom 1998)
  • As well, farmers are increasingly active in R&D through producer association check-off schemes (Alston, Pardey, and Smith 1998)
  • Return to agricultural R&D is generally high, both for producers and for society, so R&D investment is typically inefficiently low (Alston, Marra, Pardey and Watt 1998, Brinkman 2004)
producer associations in supply managed industries
Producer Associations in Supply-Managed Industries
  • Canada utilizes supply management for the production of dairy, poultry, eggs and other select commodities
  • Producers in supply-managed industries are required to contribute a portion of their sales to their association (i.e., a mandatory levy)
  • A sizeable fraction of the total levy is ear-tagged for R&D
  • Dairy Farmers of Canada invests annually up to $1.7 million in health and nutrition research, and dairy production research
r d incentives with without sm
R&D Incentives with & without SM
  • SM schemes are often criticized because of non-competitive domestic pricing, restricted imports and a constrained operating environment for processors
  • Can SM schemes also be criticized on the basis of inefficient R&D incentives?
  • Specifically, do producers in SM industries contribute less to R&D because of restricted domestic production and import controls?
  • Would Canadian producers participate more actively in R&D if a future WTO agreement eliminates SM and allows for free-trade and competition?
theoretical context
Theoretical Context
  • Theoretical analysis of R&D incentives generally assume a small set of imperfectly competitive firms and R&D spillovers
  • Agricultural firms are perfectly competitive, but the association making the R&D decisions has monopoly power and faces no spillovers
  • There are no models which compare R&D incentives when both R&D and production are monopolized (current SM) with R&D incentives when R&D is monopolized and production is competitive (dismantled SM)
paper objectives
Paper Objectives
  • Theoretically compare R&D investment incentives with SM versus a competitive closed economy (R&D decisions are still monopolized)
  • Expand comparison by allowing for an open border with the U.S. (now producer association competes for market share)
    • Initially assume identical demand and production costs prior to R&D selection to isolate pure competition effects
    • Then assume Canada is a net importer prior to R&D to account for “size of the market” effects of SM reform
  • Assume R&D reduces cost rather than creates new products
review of theoretical issues
Review of Theoretical Issues
  • Schumpeter (1942) argues that monopoly and large scale promote R&D investment because more benefits can be captured and the economic environment is more stable
  • Others argue that competition promotes R&D investment because firms that fail to innovate operate at higher relative cost and lose market share
  • In an oligopoly environment, spillovers reduce a firm’s R&D incentives because of impact on rival firm’s cost (d’Aspermont and Jacquemin 1988)
  • Firms have an incentive to set up research joint ventures and/or R&D cartels, and these are typically socially efficient (Kamien, Muller and Zang 1992)
closed economy
Closed Economy

Result 1: In a closed economy, R&D incentives are stronger with versus without SM

  • In a competitive environment with relatively elastic demand, consumers capture large share of R&D surplus
  • SM retains higher fraction of R&D surplus for producers
  • Suppose supply is linear with slope  and intercept c, and suppose demand function is P(Q)
  • Assume R&D decreases c
  • SM: Competition:
closed economy illustrated
Closed Economy Illustrated

R&D Induced Shift

SM

Competitive

Gain is positive

Gain is small or negative

open economy
Open Economy
  • In the closed economy model, the SM producer association faces no competition
  • Competition in the form of free trade should induce the producer association to invest more in R&D
open economy model
Open Economy Model
  • Demand: P = H – Q for home

P = F – Q for foreign

  • Supply: MC = h + Q for home

MC = f + Q for foreign

Where: h = h0 – xh - xF

f = f0 – xF - xH

 (0, 1) is the spillover parameter

  • Cost of R&D is quadratric
  • Let xSM, xC and xT denote optimal R&D levels for H with SM, closed competition and open competition
pure competition effects no spillover two countries are identical prior to r d decision
Pure Competition Effects: No SpilloverTwo Countries are identical prior to R&D Decision

Country H

Country F

Excess Supply

Excess Demand

Becomes net importer due to lower R&D

Becomes net exporter due to higher R&D

result 2 pure competition effect
Result 2: Pure Competition Effect
  • Suppose trading countries are identical prior to R&D, and suppose spillovers are zero. In two-stage game equilibrium:

xC < xSM < xT

  • The concern over market share lost to imports induces the producer association to invest relatively more aggressively
result 3 impact of spillover
Result 3: Impact of Spillover
  • Suppose trading countries are identical prior to R&D
    • An increase in the spillover parameter, , reduces optimal R&D
    • For a low to moderate value of 

xC < xT < xSM

    • For a relatively high value of 

xT < xC < xSM

intuition for result 3
Intuition for Result 3
  • As H increases x, F also becomes more competitive due to the spillover
  • H will therefore choose a smaller value of x to account for this externality
  • There exists a critical value for  which ensures R&D expenditures are equal with SM and with open borders
  • If R&D spillover is high (i.e., above critical value), then dismantling SM will result in a lower level of producer contributions to R&D
r d joint ventures
R&D Joint Ventures
  • R&D joint ventures (RJV) are common in industries such as biotechnology and telecommunications
  • In our model, RJV implies agreeing to share R&D results ( = 1) while still choosing x non-cooperatively
  • Kamien, Muller and Zang (1992) show that with imperfect competition, RJV result in lower R&D levels but higher profits for each firm
  • Similar results are obtained in this competitive model of R&D: raising  increases surplus for producers and society, but reduces R&D spending
  • Considerable evidence of R&D cooperation in agriculture
net importer scenario
Net Importer Scenario
  • The assumption of equal-sized trading partners is now relaxed
  • Assume that with open borders, H is a net importer prior to choosing R&D
  • Opening the border therefore reduces the size of H’s market (refer to this as the “market scale” effect)
  • Walk through the two alternative scenarios of: (a) no spillovers; (b) positive spillovers
result 4 market scale effects
Result 4: Market Scale Effects
  • Suppose H is a net importer after SM is dismantled but prior to R&D choice. Suppose the spillover is zero.
    • If pre-R&D imports are small, then the competition effect dominates and xT > xSM
    • If pre-R&D imports are relatively large, then the market scale effect dominates and xT < xSM
  • One of these two scenarios corresponds to the Canadian case
result 5 market scale and spillovers
Result 5: Market Scale and Spillovers
  • Suppose H is a net importer after SM is dismantled but prior to R&D choice. Suppose the spillover is positive.
    • An increase in the spillover induces F to invest less heavily in R&D
    • An increase in the spillover initially induces H to invest more heavily in R&D but eventually induces H to invest less heavily in R&D
  • In other words, for small values of β, R&D choices for H and F are strategic substitutes and for larger values of β, the choices are strategic complements
conclusions
Conclusions
  • Despite a large literature on R&D incentives, no obvious implications for SM
  • Considerable theoretical ambiguity regarding whether R&D incentives will improve or worsen with a dismantling of SM
  • Framework is highly simplistic
  • Additional theoretical and empirical work warranted

Financial support from Canadian Agricultural Innovation Research Network (CAIRN gratefully acknowldged