Innovation, R&D Spillovers, and the Variety and Concentration of the Local Industry Structure*

• Published date: 01 July 2020
• DOI: http://doi.org/10.1111/sjoe.12368
• Date: 01 July 2020

Scand. J. of Economics 122(3), 1231–1255, 2020

DOI: 10.1111/sjoe.12368

Innovation, R&D Spillovers, and the Variety

and Concentration of the Local Industry

Structure*

Samuli Lepp¨al¨a

Cardiff University, Cardiff CF10 3EU, UK

leppalasm@cardiff.ac.uk

Abstract

This paper presents a Cournot oligopoly model with R&D spillovers both within and across

industries. The aim is to provide a theoretical foundation for the main hypotheses regardingthe

effect of the local industry structure on innovation and output. Depending on the spilloverrates

and the degree of product differentiation between the industries, the firms respond differently to

changes in varietyand concentration, which can explain the mixed empirical results. Furthermore,

innovation and output can react in opposite ways, which makes the choice of the performance

measure critical.

Keywords: Concentration; knowledge spillover; innovation; regional economy; variety

JEL classification:L13; O31; R11

I. Introduction

Since Glaeser et al. (1992), numerous empirical studies have attempted to

determine which local industry structures are most conducive to innovation,

in terms of their variety and concentration. That is, whether regional

diversity or specialization, and similarly local competition or concentration,

encourages innovation and growth. However, the empirical results have been

inconclusive and ambiguous, as the main competing hypotheses have all

found some support (Beaudry and Schiffauerova, 2009; De Groot et al.,

2009, 2016).

A further difficulty when trying to make sense of these mixed findings

is the lack of fully developed theories about how the local industry

structure affects innovation. The theoretical foundations can be sought from

industrial economics, where there have been many theoretical studies of

R&D spillovers and innovation incentives. However, most of these studies

*I would like to thank two anonymousreferees, and the seminar audiences at Cardiff University,

Forum Innovation VI in Paris, RSA Winter Conference in London, RES Conference in

Manchester, and ACE Seminar in Turku for their helpful comments and suggestions. Any

remaining errors are my own.

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The editors of The Scandinavian Journal of Economics 2019.

1232 Innovation, R&D spillovers, and local industry structure

have focused on spillovers within a single industry and the desirability of

R&D cooperation in this context (see De Bondt, 1997).

Few studies have considered the simultaneous occurrence of intra- and

inter-industry knowledge spillovers. Among them, Steurs (1995) examined

the case of a two-industry, two-firm-per-industry model, and allowed

R&D spillovers to occur both within and between industries. The Steurs

model demonstrates that the two spillover channels have different but

interdependent effects on R&D, but not how the local industry structure

affects the outcome. As noted by several authors, among the micro-

foundations of urban agglomeration, learning and knowledge spillovers are

the least understood, and thus there is an urgent need to advance theoretical

research into localized knowledge spillovers, which should inform empirical

research rather than lagging behind it (Duranton and Puga, 2004; Fujita and

Krugman, 2004; Puga, 2010).

The present study builds on previous theoretical research by considering

the case of non-cooperative Cournot firms, which invest in cost-reducing or

demand-enhancing technologies that can spill within and across industries.

The model of Steurs (1995) is extended to consider several industries,

the products of which can be complements, independent, or imperfect

substitutes, as well as several firms within each of industry. The main

theoretical contribution is to show how the level of concentration within

local industries and the variety of these industries affect innovation and

output. The aim is to bring some clarity to the mixed empirical results and

the overall implications for regional economic policy.

The results show that whether variety and concentration increase or

decrease effective R&D and the industry output depends, in particular, on

both spillover rates and the degree of product differentiation. I also show

that the inverted-U relationship between competition and innovation can

arise as a result of the combination of inter- and intra-industry spillovers.

The marginal effects of variety and concentration on innovation and output

might be opposite, which indicates why the choice of the performance

measure can affect the empirical results. Similarly, the outcome is shown

to differ when a relative rather than an absolute measure of variety is used,

both of which are common in empirical research.

The remainder of this paper is organized as follows. In Section II, I

provide a brief review of theoretical and empirical research into inter- and

intra-industry knowledge spillovers. In Section III, I present the theoretical

model and its equilibrium analysis. The main research questions concern

the comparative statics, particularly how the effective R&D and total

industry output respond to changes in the variety and concentration of

local industries, which are studied in Section IV. In Section V, I consider

extensions to the baseline model in terms of relative variety and industry-

specific concentration. The modelling choices and heterogeneity between

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The editors of The Scandinavian Journal of Economics 2019.