Solving a hold-up problem may harm all firms: Downstream R&D and transport-price contracts

Abstract

In vertical relations, by raising input price after downstream research and development (R&D) investment, upstream firms can extract the R&D benefit and have an incentive to set higher input price. As downstream firms underinvest for fear of this hold-up by upstream firms, outputs and input-demand shrink, and all firms become worse off. Previous literature emphasizes that a fixed-price contract in which upstream firms first commit themselves to input prices and downstream firms subsequently invest can resolve the hold-up problem and make all firms better off. By contrast, we show that in a vertical relation between firm-specific carriers and exporters, the fixed-price contract of transport price can make all firms worse off because an efficiency improvement in exporters intensifies inter-regional competition. We also discuss the robustness of the result.

Endogenous transport price, R&D spillovers, and trade

“…However, since the domestic supply drops sharply as the number of carriers increases if the spillover rate is sufficiently high, a higher number of carriers can reduce consumer surplus. This paper is most closely related to those of Takauchi (2015) and Takauchi and Mizuno (2019a), who employ a similar market structure. In their setting, exporting firms must pay a freight charge to ship their products to their rival's domestic market, but freely supply to their local market.…”

“…A notable difference between this paper and the existing literature is that the transport price is endogenously determined by price competition among carriers. The existing trade studies that focus on the transport sector assume monopoly or quantity competition in the interregional transportation market (Asturias, 2020; Behrens et al, 2009; Behrens & Picard, 2011; Francois & Wooton, 2001; Ishikawa & Tarui, 2018; Takauchi, 2015; Takauchi & Mizuno, 2019). Francois and Wooton (2001) focus on an imperfectly competitive transport sector and examine the effect of tariff reductions in a competitive framework.…”

“…While all these studies use different models to provide useful insights, they assume noninnovative exporting firms. Contrary to these studies, Takauchi (2015) and Takauchi and Mizuno (2019) consider process innovation (i.e., cost‐reducing R&D) of exporting firms under two‐way trade. Takauchi (2015) examines the effect of the cost efficiency of R&D on exporting firms’ profits.…”

“…Takauchi (2015) examines the effect of the cost efficiency of R&D on exporting firms’ profits. Takauchi and Mizuno (2019) consider a hold‐up problem resulting from carriers raising prices after observing an exporting firm's investment.…”

“…5 Dinda and Mukherjee (2014) show that when the government offers the optimal uniform subsidy/tax, a higher number of inefficient firms harms consumers, although in a different context. (2015) and Takauchi and Mizuno (2019) consider process innovation (i.e., cost-reducing R&D) of exporting firms under two-way trade. 7 Takauchi (2015) examines the effect of the cost efficiency of R&D on exporting firms' profits.…”