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Competition and innovation: an inverted U relationship

Aghion, P.; Bloom, N.; Blundell, R.; Griffith, R.; Howitt, P.; (2002) Competition and innovation: an inverted U relationship. (IFS Working Papers W02/04). Institute for Fiscal Studies: London, UK. Green open access

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This paper investigates the relationship between product market competition (PMC) and innovation. A Schumpeterian growth model is developed in which firms innovate ‘step-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 ‘neck-and-neckness’ among firms should decrease with PMC. Third, the higher the average degree of ‘neck-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.

Type: Working / discussion paper
Title: Competition and innovation: an inverted U relationship
Open access status: An open access version is available from UCL Discovery
Publisher version: http://www.ifs.org.uk/publications/2017
Language: English
Additional information: Please see http://eprints.ucl.ac.uk/2572/ for the Discussion Papers in Economics version, and see http://eprints.ucl.ac.uk/17786/ for the NBER Working Paper version
UCL classification: UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS > Dept of Economics
URI: https://discovery.ucl.ac.uk/id/eprint/2962
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