Before WW2, The US military, led by the Navy, bet almost the entire shop on radial engine technology. Major engine companies like Wright and Pratt and Whitney specialised in these at the expense of water cooled engines.
Only one , Allison who became part of GM just before the war, made any water cooled engines. The Mustang was made to order for the British who specified an inline water cooled engine. As used in the P40, the Allison was the only one available made in the US.
So the Allison was fitted but it was disappointing as it had limited performance at the altitudes the war was being fought in Europe as its supercharger was a rather basic single stage device, even if the actual engine was quite good. It needed a two stage supercharger to perform well at altitude . Allison didnt make one, and even if they did, there was no room for a second stage in the Mustangs nose behind the Allison engine.
In the meantime, Rolls Royce had produced an updated version of the Merlin engine with a very neat and compact two stage supercharger. Also meantime Packard has seen that there was a serious problem with only having one major water cooled engine manufacturer in the US so had licenced the ealier single stage Merlin from Rolls Royce. Packard production was shared between the UK and the US.
Rolls Royce tested the Mustang with the Merlin and found it transformed the performance. So from the B series Mustang onwards, it was fitted with the two stage supercharged Merlin, made under licence.
Source: Bill Buckley (Quora)
