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Driving the Hard Bargain for Australian RD

Driving the Hard Bargain for Australian RD

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Published by Joshua Gans
Joshua Gans "Driving the Hard Bargain for Australian R&D", 1 July, 1997
Joshua Gans "Driving the Hard Bargain for Australian R&D", 1 July, 1997

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Published by: Joshua Gans on Jan 18, 2010
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Driving the Hard Bargain for Australian R&D
S. G
Melbourne Business SchoolUniversity of Melbourne
First Draft: 13 June, 1997This Version: 1 July, 1997
This paper evaluates the long-standing argument that Australian R&Dlevels are low because of the restrictions imposed by scale economies inproduction. In so doing, it is assumed that there are no intrinsic advantages ordisadvantages to the integration of research and production activities within asingle firm. The rents that Australian firms could accrue by sellinginnovations to overseas firms with production capabilities are thendetermined. It is demonstrated that existing overseas firms with their own in-house research units will have a greater intrinsic willingness to pay forinnovations. Hence, they will spend relatively more on R&D and innovatemore often than Australian research-oriented firms.
 Journal of Economic Literature
Classification Numbers: L22, O32.
: research and development, bargaining, patent licensing, economiesof scale.
Thanks to Shannon Mitchell and Robin Stonecash for very useful comments on an earlier draft this paper.Financial assistance from a Special Initiatives Grant, University of Melbourne, is gratefully acknowledged.Responsibility for all errors lies with me. E-mail comments to J.Gans@mbs.unimelb.edu.au. The latestversion of this paper is available at: http://www.mbs.unimelb.edu.au/home/jgans .
2In a recent issue of 
, Mitchell and Stonecash
took the position that, inunderstanding the process of research and development in Australia, it is useful todistinguish between the separate tasks of inventing an idea as opposed to deriving returnsfrom that idea in production. They noted that a long standing argument as to whyAustralian businesses appeared to allocate a lower proportion of resources to research anddevelopment than firms in other countries was based on an assumption that the researchand production tasks must be integrated within a single organisation. The traditionalargument held that, as many of the most innovative industries involved productiontechnologies with scale economies, Australian firms, facing a small domestic market fortheir products, could not gain as high a return from innovation than their overseascounterparts. Hence, they would engage in less research activity.
Mitchell and Stonecash challenged the traditional argument on two grounds. First,there is no a priori reason to suppose that research activity must be integrated withproduction to yield an economic return. Indeed, many innovations, whether patentable ornot, are potentially commodifiable ideas that could be sold to firms in larger markets.Those firms could then turn the innovative idea into a marketable product. So there need beno particular reason why Australian innovators could not access production facilitieslocated in larger markets. Moreover, even if there were some reason as to why researchand production were inseparable, Mitchell and Stonecash argued, secondly, that, unlessthere were prohibitively high transportation costs or trade barriers, Australian firms could,in principle, still realise scale economies by selling to the larger world markets.
Figure One provides a simple taxonomy of each of these arguments regarding theconstraints production scale economies place on incentives to undertake research and 
Shannon K. Mitchell and Robin E. Stonecash, “The Role of Economies of Scale in Australian R&D,”
, 14 (2), pp.152-167.
Robert Gregory, “The Australian Innovation System,” in R.R. Nelson (ed.)
 National InnovationSystems: A Comparative Analysis, Oxford University Press
, New York, 1993.
As Mitchell and Stonecash,
., acknowledge, this latter argument rests on Australian firms being atleast as efficient in production as their overseas counterparts.
3development. Observe that the traditional argument occupies one quadrant of the diagramwhile in each of the rest it is possible that research incentives could be quite high despitebeing located in a small market. Mitchell and Stonecash supported their challenge to thetraditional view by identifying examples in each of these other quadrants. For instance, theSarich orbital engine involved an innovation in an industry with high trade and transportbarriers but that did not prevent the idea itself being exported overseas to where thatindustry was concentrated. A similar analysis applied to Australian generatedpharamaceutical innovations where this time the important barrier to production was accessto overseas distribution networks. Finally, innovations in mining represented situations inwhich research was either integrated into an industry with scale economies but withrelatively low trade barriers or, alternatively, Australian firms both produced and exportedideas elsewhere. Figure One: Taxonomy of ArgumentsTrade and Transport BarriersStrongWeaAdvantages toIntegration of HighScale economiesconstrain domesticresearchConduct domesticresearch and exportproduced goodsResearch andProductionLowConduct researchand export ideasConduct domesticresearch and exportideas and producedgoodsWhile Mitchell and Stonecash presented a very persuasive argument as to why thetraditional argument, as to how scale economies constrain domestic research incentives,was naive, they did not offer any explanation as to why Australia did not appear to have anoverall comparative advantage in research and development. In particular, they argued thatthe advantages to integrating research and production were likely to be industry specific,being high in some industries and low in others. However, this implies that Australian

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