Are Markups Too High? Competition, Strategic Innovation, and Industry Dynamics

142 Pages Posted: 6 Oct 2019 Last revised: 26 Oct 2023

See all articles by Laurent Cavenaile

Laurent Cavenaile

University of Toronto at Scarborough; University of Toronto - Rotman School of Management

Murat Alp Celik

University of Toronto - Department of Economics

Xu Tian

University of Georgia - Terry College of Business - Department of Finance

Date Written: August 1, 2019

Abstract

To study competition, innovation, and industry dynamics that arise as a result of their interaction, we develop a new oligopolistic general-equilibrium Schumpeterian growth model. This model ties together the endogenous growth, oligopolistic competition, and dynamic industrial organization literatures in a single unified framework, which is used to assess the growth and welfare implications of counterfactuals. Within each industry, there are an endogenously determined number of large firms ("superstars") that compete a la Cournot and a continuum of small firms which collectively constitute a competitive fringe. Firms dynamically choose their innovation strategies, cognizant of other firms' choices, and their entry and exit are endogenous. The model is consistent with the macroeconomic trends observed in the United States since the 1970s, such as the domination of industries by a small number of superstar firms, the rise of markups, market concentration, profits, and R&D spending, and the decline in business dynamism, productivity growth, and the labor share. It replicates the empirical relationship between innovation and competition within and across industries. As an application, we estimate the model to disentangle the effects of separate mechanisms on the structural transition observed in the United States, which yields striking results: (1) While the increase in the average markup causes a significant static welfare loss, this loss is overshadowed by the dynamic welfare gains from increased innovation in response to higher profit opportunities. (2) The increasing costs of innovation are found to be the primary determinant of lackluster productivity growth, i.e., ideas are getting harder to find.

Keywords: innovation, markups, growth, strategic investment, industry dynamics, business dynamism

JEL Classification: E20, L10, O30, O40

Suggested Citation

Cavenaile, Laurent and Celik, Murat Alp and Tian, Xu, Are Markups Too High? Competition, Strategic Innovation, and Industry Dynamics (August 1, 2019). Available at SSRN: https://ssrn.com/abstract=3459775 or http://dx.doi.org/10.2139/ssrn.3459775

Laurent Cavenaile

University of Toronto at Scarborough ( email )

1265 Military Trail
Scarborough, Ontario M1C 1A4
Canada

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Murat Alp Celik (Contact Author)

University of Toronto - Department of Economics ( email )

150 St. George St.
Toronto, ON M5S 3G7
Canada

HOME PAGE: http://muratcelik.faculty.economics.utoronto.ca/

Xu Tian

University of Georgia - Terry College of Business - Department of Finance ( email )

620 S Lumpkin St
Athens, GA 30602
United States

HOME PAGE: http://www.xutianur.com

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