R&D and the Persistence of Profits

Economic theory tells us that abnormal firm and industry profits will not persist for any significant length of time. Any firm or industry making profits in excess of the normal rate of return, will attract entrants and this competitive process will erode their profits. However, a substantial amount of research has found evidence of persistent profits above the norm. Barriers to entry and exit, is an explanation often put forward to this anomaly. In the absence of, or with low barriers to entry and exit, this reasoning provides little help in explaining why these above-norm profits arise and persist. This paper explores the links between the systematic search for knowledge and the persistence of profits. By investing in R&D (Research and Development) firms may succeed in creating products or services that are preferred by the market and/or find a more cost efficient method of production. Corporations that systematically invest in R&D may, by doing this, offset the erosion of profits and thereby have persistently high profits, which diverge from the competitive return. The paper argues that even in the absence of significant barriers to entry and exit, profits may persist. This can be accredited to a systematic search for knowledge through R&D.