This paper investigates the views on competition theory and policy of the American institutional economists during the first half of the 20th century. These perspectives contrasted with those of contemporary neoclassical and later mainstream economic approaches. We identify three distinct dimensions to an institutionalist perspective on competition. First, institutionalist approaches focused on describing industry details, so as to bring theory into closer contact with reality. Second, institutionalists emphasized that while competition was sometimes beneficial, it could also be disruptive. Third, institutionalists had a broad view of the objectives of competition policy that extended beyond effects on consumer welfare. Consequently, institutionalists advocated for a wide range of policies to enhance competition, including industrial self-regulation, broad stakeholder representation within corporations, and direct governmental regulations. Their experimental attitude implied that policy would always be evolving, and antitrust enforcement might be only one stage in the development toward a regime of industrial regulation.

When observably heterogeneous firms engage in R&D and policy can be conditioned on the heterogeneity, what is the optimal policy? This paper starts with a static duopoly model of R&D competition with uncertainty and finds it welfare enhancing to subsidize the larger firms with no subsidies for the smaller firm, extending existing results. This result follows because the policymaker’s goal is to minimize the average cost of production. Our paper demonstrates that these results are not robust to a dynamic setting. The optimal policy depends on the equilibrium type of competition that emerges without intervention—an insight that cannot be found in a static setting. In a dynamic setting, the degree of competition becomes an endogenous variable. Interestingly, although the optimal policy in some cases provides a slightly larger subsidy for the larger firm, it is the smaller firm that benefits most in terms of firm value.