Concentration and Other Determinants of Innovative Efforts in Indian Manufacturing Sector: A Dynamic Panel Data Analysis

Abstract

The relationship between market concentration and innovative efforts by firms has attracted a lot of attention by researchers. However, a consensus is yet to emerge on the conceptual underpinnings and empirical manifestations of this relationship. While Schumpeter (1942) argued that existence of large firms in imperfectly competitive markets provides the most conducive condition for technical progress, Arrow (1962) pointed out that a pre-innovation monopolist has weaker incentive to innovate than a firm operating in a competitive market. However, even a monopolist faced with contestable markets may be forced to undertake innovative activities to meet ‘potential competition’. Further, R&D efforts by a firm are likely to depend on a variety of risks in the market and an increase in such risks may discourage firms to spend on in-house R&D. This is particularly so as expenditure on R&D by a firm is an endogenous sunk cost (Sutton, 1991) and significant innovative efforts by a firm do not always yield success in the market (Scherer, 2000). Given the difficulty in predicting the demand patterns of the consumers and R&D strategies of the rivals with information asymmetries, there is a large stochastic component in R&D spending and economic returns. In addition, possibility of disclosure of the outcomes of publicly funded R&D projects also poses threat on the rate of returns and, therefore, may reduce firms’ own R&D expenditure. Given such importance of risks, it is potential/expected market structure and not actual concentration that is likely to influence innovative efforts by the firms. Although the existing studies have attempted to explore different aspects of R&D efforts in Indian manufacturing (e.g., Kumar and Agarwal, 2000), examining the role of potential market concentration in determining R&D efforts is largely ignored. The present paper attempts to fill in this gap. The basic objective of the present paper is to understand the role of expected market concentration in determining inter-industry variations in R&D efforts in Indian manufacturing sector, controlling for various other aspects of market structure, firms’ conduct (other than R&D), their performance, and policy related aspects. The paper is based on the proposition of Kamien and Schwartz (1982) that market power interacts with a firm’s decision to make innovative efforts via anticipated market power. It is assumed that higher the anticipated market power associated with the post-innovation industry, the innovators have greater incentive to innovate. This is so because larger anticipated market power promises higher profits in future and hence can compensate for current R&D investment. We use Arellano-Bond dynamic panel estimation techniqueand a panel dataset of 34 manufacturing industries over the period from 2001-02 to 2008-09. The paper finds that firms in industries with greater R&D efforts in the past, larger participation of the MNCs, higher capital intensity, and greater penetration in the international market through exports spend more on innovation. On the other hand, inhouse R&D efforts are less in the industries with larger incidence of mergers and acquisitions and greater competition from imports. However, the degree of sellers’ concentration in a market, size of the market, efforts by the firms towards creation of product differentiation and image advantage, purchase of technology, and the level and variations in their profitability do not make any significant difference in in-house R&D intensity across the industries. The findings of the present paper raise some important policy concerns relating to investment, trade and competition. Should restrictions on entry of MNCs be relaxed further and exports encouraged for promoting in-house R&D? Should M&As be restricted as they hinder in-house R&D efforts? How to encourage the MNCs to enter through Greenfield investment, instead of M&As? Answering these questions requires detailed understanding of technology strategies at the firm level and, therefore, leaves interesting areas for further research.