Appropriating t he Returns from Industrial Research and Development To HAVE the incentive to undertake research and development, a firm must be able to appropriate returns sufficient to make the investment worthwhile. The benefits consumers derive from an innovation, however, are increased if competitors can imitate and improve on the innovation to ensure its availability on favorable terms. Patent law seeks to resolve this tension between incentives for innovation and widespread diffusion of benefits. A patent confers, in theory, perfect appropriability (monopoly of the invention) for a limited time in return for a public We are grateful for the support of the National Science Foundation and especially to Rolf Piekarz of the NSF's Division of Policy Research and Analysis. We also wish to thank the 650 respondents to our survey and the R&D executives who helped us pretest it-especially Ralph Gomory,

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for valuable suggestions. The representations and conclusions presented herein are those of the authors. They have not been adopted in whole or in part by the Federal Trade Commission, its Bureau of Economics, or any other entity within the Commission. The FTC's Disclosure Avoidance Officer has certified that the data included in this paper do not identify individual company line of business data. The research reported here is part of the NBER's research program in Productivity. Any opinions expressed are those of the authors and not those of the National Bureau of Economic Research.

This paper analyzes R&D policies when the returns to cost-reducing and demand-creating R&D are imperfectly appropriable and market structure is endogenous. Previous characterizations of appropriability are generalized to permit the possibility that own and rival R&D are imperfect substitutes. We also describe how equilibrium expenditures on process and product R&D, as well as equilibrium market structure, depend on technological opportunities and spillovers. In contrast to previous work, diminished appropriability does not necessarily reduce R&D expenditures. For example, under some conditions, an increase in the extent of process (product) spillovers will lead to an increase in product (process) R&D. We estimate several variants of the model using manufacturing line of business data and data from a survey of R&D executives. their comments. We also received very helpful comments from Stanley Besen, Michael Salinger, and an anonymous referee. Financial support was provided by the National Science Foundation's Division of Policy Research and Analysis, the Fletcher Jones Foundation, and Reiss' Olin Fellowship at the NBER. 2 Major contributions to this literature are surveyed by Dasgupta (1986) and Baldwin and Scott (1987). Among the models that have focused upon the relationship between cost-reducing R&D and market structure are: Dasgupta and