9. THE RELATIONSHIP BETWEEN SOCIAL AND PRIVATE RETURNS

From the point of view of the ATP program, the gap between social and private rates of return from investments in new technology is of central importance. After all, a major rationale for the ATP program is that some R&D projects have social rates of return far in excess of their private rates of return. What determines the gap between the social and private rates of return? One relevant factor is the market structure of the innovator's industry. If the innovator is faced with a highly competitive environment, it is less likely that it will be able to appropriate a large proportion of the social benefits than if it has a secure-monopoly position or if it is part of a tight oligopoly. Of course, the extent to which the innovator is subjected to competition, and how rapidly, may depend on whether the innovation is patented. Another consideration of at least equal importance is how expensive it is for potential competitors to "invent around" the innovator's patents, if they exist, and to obtain the equipment needed to begin producing the new product (or using the new process). In some cases, like duPont's nylon, it would have been extremely difficult to imitate the innovation (legally). In other cases, a potential competitor could obtain and begin producing a "me too" product (or using a "me too" process) at relatively little cost.

Another factor that economists have emphasized as a determinant of the size of the gap between social and private rates of return is whether the innovation is major or minor. According to R.C.O. Matthews (1973), the "degree of appropriability is likely to be less in major innovations than in minor ones...," since major innovations are more likely, in his view, to be imitated quickly. Similarly, on the basis of a model stressing the indivisibility of information, Kenneth Arrow (1962) concluded that "the inventor obtains the entire realized social benefit of moderately cost reducing inventions but not of more radical inventions."

Still another factor that is sometimes cited is whether the innovation is a new product or process. Thus, Matthews hypothesized that the degree of appropriability might be less for process innovations than for product innovations. On the other hand, Nelson, Peck, and Kalachek (1967) stressed that new processes can often be kept secret and that it frequently is difficult for one firm to find out what processes another firm is using. This, of course, suggests that the gap between social and private rates of return might be greater for products than for processes.

Although most of these hypotheses seem quite plausible, the unfortunate fact seems to be that they have been subjected to only one systematic empirical test, which was based on data for only about 20 innovations (Mansfield et al, 1977). The results seem to support the hypotheses that the gap between social and private rates of return tends to be greater for more important innovations and for innovations that can be imitated relatively cheaply by competitors. Apparently, when the cost of imitating the innovation is held constant, it makes little or no difference whether the innovation is patented—which seems reasonable because whether or not a patent exists is of relevance largely (perhaps only) because of its effects on the costs of imitation. It is worth noting that this simple model can explain about two-thirds of the observed variation in this gap among the product innovations in our sample. However, at the same time, it is important to bear in mind the smallness (and age) of the sample.

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Date created: June 15, 2006
Last updated: June 16, 2006

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