Competition and Innovation: An Inverted U Relationship
Harvard University - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
Stanford University - Department of Economics; Stanford Graduate School of Business; London School of Economics - Centre for Economic Performance (CEP); National Bureau of Economic Research (NBER)
Richard W. Blundell
UCL; IFS; Institute for the Study of Labor (IZA); Centre for Economic Policy Research (CEPR)
Institute for Fiscal Studies (IFS); University of Manchester; Centre for Economic Policy Research (CEPR)
Brown University - Department of Economics; National Bureau of Economic Research (NBER)
June 7, 2004
Advanced Institute of Management Research Paper No. 007
This paper investigates the relationship between product market competition and innovation. It uses the radical policy reforms in the UK as instruments for changes in product market competition, and finds a robust inverted-U relationship between competition and patenting. It then develops an endogenousm growth model with step-by-step innovation that can deliver this inverted-U pattern.
In this model, competition has an ambiguous effect on innovation. On the one hand, it discourages laggard firms from innovating, as it reduces their rents from catching up with the leaders in the same industry. On the other hand, it encourages neck-and-neck firms to innovate in order to escape competition with their rival. The inverted-U pattern results from the interplay between these two effects, together with the effect of competition on the equilibrium industry structure. The model generates two additional predictions: on the relationship between competition and the average technological distance between leaders and followers across industries; and on the relationship between the distance of an industry to its technological frontier and the steepness of the inverted-U. Both predictions are supported by the data.
Number of Pages in PDF File: 43working papers series
Date posted: November 25, 2008
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