The Source of Comparative Advantage in Biotechnology:
A Real Options Approach

Brian F. Lavoie and Ian M. Sheldon
The Ohio State University
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Commercial biotechnology has historically been dominated by US firms. In 1996, US biotechnology firms numbered 1,287 and employed 118,000 workers, compared to 716 firms and 27,500 workers in all of Europe. US firms earned $14.6 billion in revenues, dwarfing the European total of $1.4 billion. US biotechnology firms spent $7.9 billion on research and development (R&D); European firms spent only $1.2 billion (Ernst & Young, 1997).

International trade theory holds that the US comparative advantage in biotechnology may be explained by the presence of some form of heterogeneity in the international economy. A set of stylized facts characterizing biotechnology R&D investment suggests that the US comparative advantage in biotechnology can be explained through sources of heterogeneity within the R&D investment process. Modeling the R&D investment process using a real options approach elucidates several empirically observable sources of heterogeneity favoring the US: in particular, the per-period rate of investment and the level of uncertainty associated with the regulatory regime governing the industry.

Simulation results corroborate the hypothesis that biotechnology firms exhibiting a higher per-period rate of investment and less uncertainty over the regulatory regime will tend to initiate more R&D projects, commence investment sooner, innovate more rapidly, persevere longer in the face of mounting R&D costs, and ultimately, successfully complete more projects. Extension of these results to an industry-level setting offers a plausible explanation for the US comparative advantage in biotechnology.