Internalization of Knowledge Spillovers in R&D Joint Ventures

Under constant returns to scale the only justification for joint ventures are externalities from knowledge spillovers. In a two-stage game we compare the incentives for integrated cartels and cartels with downstream competition. The externalities introduce an underinvestment incentive. Under downstream competition this effect is reinforced because a commitment to higher short run marginal costs increases the profits. In the integrated cartels the effect is partly offset by an overinvestment effect, because lower marginal costs lead to higher market shares. In an example we study the tradeoff between productive and allocative efficiency.