Expenditure in R&D and Market Power: Theory and Evidence

Abstract

Since Schumpeter (1950), until more recent work such as Aghion et al. (2002), there exists a large literature analyzing the relationship between R&D and market power. This paper follows this tradition and analyzes the relationship between R&D expenditures and market power in the Brazilian economy. We use a new dataset: the IBMEC-Sensus 2008 survey. Besides information on R&D expenditure, this dataset contains an estimate of the price-elasticity of demand faced by the firm, information we use as an exogenous instrument for market power. We use the model from Aghion at al. (2002), which proposes an inverted-U relationship between R&D and market power – measured by the Lerner index – to justify the functional form we adopt in our econometric model. Our first results do not reject an inverted-U relationship between both variables. However, when we estimate the model using the inverse of the demand elasticity as an instrument for market power, this relationship loses significance, showing that the relation between R&D and market power could simply be a consequence of the simultaneous determination of both variables by a third and omitted variable. We conclude that there is no causality from market power to R&D.