Concentration and Innovation in the Defence Industry: A Stochastic Game

The relationship between industry structure, aggregate R&D activity and the quality level of the resulting innovation is investigated in a simple stochastic one-shot game in which all firms share the same probability of attaining the innovation concerning a new weapon system and therefore obtaining the contract from the government. The main findings of the game can be summarised as follows. Although only performing numerical calculations, the model predicts the existence of a concave and single-peaked relationship between aggregate R&D and industry structure, making it desirable to adjust concentration in order to reach that peak. However, the degree of concentration that maximises the final quality level of the innovation is higher than that maximises industry-wide R&D efforts, except in the special case in which technical knowledge freely spills over across firms, thanks to the creation of a research joint venture involving all firms.