Tests on the behaviour of oligopolistic firms in the R&D arms race

Abstract

With the explosion of information knowledge in recent years, leading in the area of technology has been a key point in the competitive advantage of firms. In the traditional economic theory of the oligopoly market, the number of firms is small and each firm restrains the others in an attempt to coordinate price or output and thereby increase overall profitability. In order to remain competitive and profitable in the industry, firms emphasize R&D and innovation to utilize their knowledge and advance their technology. Baumol indicates that firms compete not only in regard to prices, but also to introduce new products and new processes into the oligopoly market. This competition means that the R&D expenditure and innovation activities are the mediums of competition and have created an arms race relationship between the firms.

This paper is built around this argument presented by Baumol. In order to test Baumol's hypothesis, we utilize firm-level data for three types of oligopoly markets – the international foundry market, the international cellular telephone market, and the Taiwan oil market – to provide empirical results from a first difference model, finite distributed lag model and a hypothesis test. The key findings of this paper are as follows – first, firms create an arms race with regard to R&D expenses while engaging in innovation activities; and second, evidence indicates that the arms race will accelerate under a more competitive oligopoly market in which technology improves rapidly.

Keywords:

• oligopoly firm
• Baumol hypothesis
• competition
• R&D
• Taiwan oil refinery market

Notes

Baumol (2002) uses the phrase to describe firms in the oligopoly market that do not withdraw from the current standard for R&D spending and change to a higher standard that all major firms are likely to feel they must match.

Nickell (1996) also finds evidence of a positive relationship between competition and innovation.

If np and n(1–p) both exceed five, we can then use the normal distribution for the test with the continuity corrections. However, if np and n(1–p) both exceed 30, then we can use the normal distribution for the test and do not need to apply the continuity corrections.

Nokia's website can be found at: http://www.nokia.com/, while Motorola's website can be found at: http://www.motorola.com/tw.