| Is more intense competition a positive for entrepreneurial innovations and, in the end, for economic growth? Over the years, economists and policy-makers have actively debated the issue. Numerous theoretical studies appear to lend support to the idea that the relationship between firms' incentive to innovate and the degree of product market competition is humped or inverse-u shaped, implying that monopoly and perfectly competitive markets provide the weakest incentives for entrepreneurial innovations. And the empirical evidence has tended to corroborate the theory. The Schumpeterian wing of endogenous growth theory has generally addressed the issue of firms' incentives to innovate by focusing on monopoly rents that accrue to successful innovators. According to this view, intense product market competition weakens entrepreneurial incentive to innovate and thereby retards economic growth, because it reduces the flow of rents to innovators. Similarly, weaker patent protection and easier imitation should also reduce entrepreneurial incentive to invest in research and development, since these tend to shorten the expected duration of rents from innovation as perceived by firms. R&D incentives, however, depend not only on income prospects of the successful innovator but also - maybe even more so - on the innovator's incremental rents, that is the difference between rents obtained by a successful innovator versus an unsuccessful one. This distinction is not made in most Schumpeterian growth models, since innovations there are made by outsiders who know that only commercially successful innovations can generate monopoly rents. Actually, in many industries most of the firms do invest in innovation activity and many are earning rents generated by innovations. Thus the rents obtained by a successful innovator may be a poor indicator of the incentive to innovate and invest in R&D activity. It is worth pointing out that increased competitive pressure in the product market can reduce a firm's pre-innovation rents by more than it reduces the post-innovation rents. Indeed, this is what one would expect as a result of the 'selection effect' of market competition: in most competitive industries the profits earned by the technological leaders are larger than those earned by other firms. Consequently, an increase in product market competition can stimulate R&D by increasing incremental profits from innovations that help firms escape from competition with their closest rivals. Moreover, firms that are imitated face stronger incentives to innovate than before, even though their prospective rents from innovations are lower than before, because they are now in neck-and-neck competition with technologically-equal rivals and will remain so until they innovate again. As a consequence, anti-trust policy directly affecting product market competition and patent legislation affecting the ease of imitation will have growth repercussions not only by directly impacting firms' innovation incentives in the different industries but also via their influence on cross-industry distributions of technological gaps and the corresponding distributions of incremental rents. |