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Competition and innovation: an inverted U relationship

Author

Listed:
  • Philippe Aghion

    (Institute for Fiscal Studies and London School of Economics)

  • Nicolas Bloom

    (Institute for Fiscal Studies)

  • Richard Blundell

    (Institute for Fiscal Studies and University College London)

  • Rachel Griffith

    (Institute for Fiscal Studies and University of Manchester)

  • Peter Howitt

    (Institute for Fiscal Studies and Brown University)

Abstract

This paper investigates the relationship between product market competition (PMC) and innovation. A Schumpeterian growth model is developed in which firms innovate ?tep-by-step? and where both technological leaders and their followers engage in R&D activities. In this model, competition may increase the incremental profit from innovating; on the other hand, competition may also reduce innovation incentives for laggards. This model generates four main predictions which we test empirically. First, the relationship between product market competition (PMC) and innovation is an inverted U-shape: the escape competition effect dominates for low initial levels of competition, whereas the Schumpeterian effect dominates at higher levels of competition. Second, the equilibrium degree of technological ?eck-and-neckness' among firms should decrease with PMC. Third, the higher the average degree of ?eck-and-neckness' in an industry, the steeper the inverted-U relationship between PMC and innovation in that industry. Fourth, firms may innovate more if subject to higher debt-pressure, especially at lower levels of PMC. We confront these four predictions with a new panel data set on UK firms' patenting activity at the US patenting office. The inverted U relationship, the neck and neck, and the debt pressure predictions are found to accord well with observed behavior in the data.

Suggested Citation

  • Philippe Aghion & Nicolas Bloom & Richard Blundell & Rachel Griffith & Peter Howitt, 2002. "Competition and innovation: an inverted U relationship," IFS Working Papers W02/04, Institute for Fiscal Studies.
    • Handle: RePEc:ifs:ifsewp:02/04
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    References listed on IDEAS

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    JEL classification:

    • O0 - Economic Development, Innovation, Technological Change, and Growth - - General
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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