Internalization of knowledge spillovers in R&D joint ventures

Under constant returns to scale the only justification for joint ventures are externalities from knowledge spillovers. In a two-stage game we compare the incentives for integrated cartels and cartels with downstream competition. The externalities introduce an underinvestment incentive. Under downstream competition this effect is reinforced because a commitment to higher short run marginal costs increases the profits. In the integrated cartels the effect is partly offset by an over-investment effect, because lower marginal costs lead to higher market shares. In an example we study the tradeoff between productive and allocative efficiency.