Selected Economic Papers
Edited by Jean-Philippe Touffut
Chapter 6: Empirical estimates of the relationship between product market competition and innovation
Philippe Aghion 1 INTRODUCTION Both the theoretical industrial organization (IO) literature and the more recent endogenous growth literature have raised the issue of the relationship between product market competition (PMC) and innovation or productivity growth. The theoretical IO literature predicts that innovation and growth should decline with competition, because more competition reduces the monopoly rents that reward entry by new successful innovators. On the other hand, empirical work has pointed to a positive correlation between product market competition and innovative output. Several theoretical attempts have been made to reconcile the Schumpeterian paradigm with the evidence provided in these studies generating various predictions as to the shape of the relationship between PMC and productivity growth. In particular, Aghion et al. (1997) and Aghion et al. (2001) extended the basic Schumpeterian model by allowing incumbent firms to innovate. In these models, innovation incentives depend not so much upon post-innovation rents per se, but more upon the difference between post-innovation and pre-innovation rents. (The latter were equal to zero in the basic model where all innovations were made by outsiders.) In this case, more PMC may end up fostering innovation and growth, as it may reduce a firm’s pre-innovation rents more than it reduces post-innovation rents. In other words, competition may increase the incremental profits from innovating, and thereby encourage R&D investments aimed at ‘escaping competition’. Hence the possibility of a positive correlation between PMC and productivity growth. Does this mean that the Schumpeterian effect highlighted in earlier models disappears and that...
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