On the Winner-Take-All Principle in Innovation Races

Abstract

What is the optimal allocation of prizes in an innovation race? Should the winner take all or is it preferable that first inventors share the market with late independent duplicators? This paper re-examines the issue taking into account that the incentives to innovate depend not only on industry profits but also on the division of profits between early and late inventors. In our baseline model two firms race for an innovation in continuous time. In the winner-take-all system as soon as one firm innovates the other stops investing in RD in the alternative more permissive system the laggard continues to invest to duplicate the innovation and when it also succeeds the market becomes a duopoly. We compare the two regimes on welfare grounds finding that the winner-take-all system can be socially optimal in a broad set of circumstances much broader than envisioned by the recent literature. We discuss why we arrive at di§erent results than the early literature and the policy implications of our analysis.