Competition and Innovation: Revisiting the Relationship Using Alternative Measures of Rivalry

• Thesis title in English: Competition and Innovation: ; Revisiting the Relationship Using Alternative Measures of Rivalry
• Key words: konkurence, inovace, pružnost zisku, proměnlivost trhu výrobků, obrácená U-křivka, negativní binomická regrese
• English key words: competition, innovation, profit elasticity, product market fluidity, inverted-U, negative binomial regression
• Academic year of topic announcement: 2012/2013
• Thesis type: diploma thesis
• Thesis language: angličtina
• Department: Institute of Economic Studies (23-IES)
• Supervisor: doc. Bc. Jiří Novák, M.Sc., Ph.D.
• Author: hidden - assigned by the advisor
• Date of registration: 19.06.2013
• Date of assignment: 19.06.2013
• Date and time of defence: 22.09.2015 00:00
• Venue of defence: IES
• Date of electronic submission: 27.07.2015
• Date of proceeded defence: 22.09.2015
• Opponents: prof. Ing. Michal Mejstřík, CSc.

Preliminary scope of work

My work will contribute to the debate between proponents of contradicting views on relationship between level of competition and incentive to innovate: those expressed in Arrow (1962) and in Schumpeter (1934). Schumpeterian proposition that perfectly competitive market cannot be considered the most efficient platform for innovation due to decreased monopoly rent was later challenged by Arrow, who argued that "the preinvention monopoly power acts as a strong disincentive to further innovation". A compromise was offered in Aghion et al. (2005), implying an "inverted-U shape" relationship between level of competition and innovation, where both "escape competition" and "Schumpeterian" motives are accounted for. In macro finance this debate is primarily narrowed down to antitrust regulation issues.

As noted by Gilbert (2006), empirical evidence on the issue is mixed. While Aghion et al. (2005), Bos et al. (2013), Hashmi (2013) and others were able to confirm the inverted-U hypothesis, the metrics of innovative performance and rivalry in the industry used in this and other research are methodologically problematic. This work will expand on the previous research by introducing qualitatively new measures of product market competition, developed in Hoberg et al. (2014) and Boone (2008), known as product market fluidity and profit elasticity respectively. Innovative performance metrics are reviewed as well, improving on typically used and widely criticized variables such as R&D expenditures and raw patent counts. In addition, following Aghion et al. (2005) and subsequent research, the thesis will account for other exogenous variables which influence competition, such as the distance of firm to technological frontier.

Finally, in order to better capture the shape of the relationship between competition and innovation, this work will draw upon the developments in Lind & Mehlum (2010), employing so–called intersection–union test of U–shape relationship, as well as other empirical techniques and testing procedures.

Aghion, P., R. Blundell, R. Griffith, & P. Howitt (2005): “Competition and Innovation: An Inverted–U Relationship.” The Quarterly Journal of Economics 120(2): pp. 701–728.

Arrow, K., (1962): “Economic Welfare and The Allocation of Resources for Invention.” In “The Rate and Direction of Inventive Activity: Economic and Social Factors,” pp. 609–626. Princeton University Press.

Boone, J. (2014): “A New Way to Measure Competition.” The Economic Journal 118(531): pp. 1245–1261.

Bos, J. W. B., J. W. Kolari, & R. C. R. van Lamoen (2013): “Competition and innovation: Evidence from Financial Services.” Journal of Banking & Finance 37(5): pp. 1590–1601.

Gilbert, R. (2006): “Looking for Mr. Schumpeter: Where are we in the Competition–Innovation Debate?” In “Innovation Policy and the Economy, Volume 6,” pp. 159–215. The MIT Press.

Hashmi, A. R. (2013): “Competition and Innovation: The Inverted–U Relationship Revisited.” Review of Economics and Statistics 95(5): pp. 1653–1668.

Hoberg, G., G. Phillips, & N. Prabhala (2014): “Product Market Threats, Payouts, and Financial Flexibility.” The Journal of Finance 69(1): pp. 293–324.

Lind, J. T., & H. Mehlum (2010): “With or Without U? The Appropriate Test for a U–Shaped Relationship.” Oxford Bulletin of Economics and Statistics 72(1): pp. 109–118.

Schumpeter, J. A. (1934): “The theory of economic development: An inquiry into profits, capital, credit, interest, and the business cycle,” volume 55. Transaction Publisher.

Preliminary scope of work in English

My work will contribute to the debate between proponents of contradicting views on relationship between level of competition and incentive to innovate: those expressed in Arrow (1962) and in Schumpeter (1934). Schumpeterian proposition that perfectly competitive market cannot be considered the most efficient platform for innovation due to decreased monopoly rent was later challenged by Arrow, who argued that "the preinvention monopoly power acts as a strong disincentive to further innovation". A compromise was offered in Aghion et al. (2005), implying an "inverted-U shape" relationship between level of competition and innovation, where both "escape competition" and "Schumpeterian" motives are accounted for. In macro finance this debate is primarily narrowed down to antitrust regulation issues.

As noted by Gilbert (2006), empirical evidence on the issue is mixed. While Aghion et al. (2005), Bos et al. (2013), Hashmi (2013) and others were able to confirm the inverted-U hypothesis, the metrics of innovative performance and rivalry in the industry used in this and other research are methodologically problematic. This work will expand on the previous research by introducing qualitatively new measures of product market competition, developed in Hoberg et al. (2014) and Boone (2008), known as product market fluidity and profit elasticity respectively. Innovative performance metrics are reviewed as well, improving on typically used and widely criticized variables such as R&D expenditures and raw patent counts. In addition, following Aghion et al. (2005) and subsequent research, the thesis will account for other exogenous variables which influence competition, such as the distance of firm to technological frontier.

Finally, in order to better capture the shape of the relationship between competition and innovation, this work will draw upon the developments in Lind & Mehlum (2010), employing so–called intersection–union test of U–shape relationship, as well as other empirical techniques and testing procedures.

Aghion, P., R. Blundell, R. Griffith, & P. Howitt (2005): “Competition and Innovation: An Inverted–U Relationship.” The Quarterly Journal of Economics 120(2): pp. 701–728.

Arrow, K., (1962): “Economic Welfare and The Allocation of Resources for Invention.” In “The Rate and Direction of Inventive Activity: Economic and Social Factors,” pp. 609–626. Princeton University Press.

Boone, J. (2014): “A New Way to Measure Competition.” The Economic Journal 118(531): pp. 1245–1261.

Bos, J. W. B., J. W. Kolari, & R. C. R. van Lamoen (2013): “Competition and innovation: Evidence from Financial Services.” Journal of Banking & Finance 37(5): pp. 1590–1601.

Gilbert, R. (2006): “Looking for Mr. Schumpeter: Where are we in the Competition–Innovation Debate?” In “Innovation Policy and the Economy, Volume 6,” pp. 159–215. The MIT Press.

Hashmi, A. R. (2013): “Competition and Innovation: The Inverted–U Relationship Revisited.” Review of Economics and Statistics 95(5): pp. 1653–1668.

Hoberg, G., G. Phillips, & N. Prabhala (2014): “Product Market Threats, Payouts, and Financial Flexibility.” The Journal of Finance 69(1): pp. 293–324.

Lind, J. T., & H. Mehlum (2010): “With or Without U? The Appropriate Test for a U–Shaped Relationship.” Oxford Bulletin of Economics and Statistics 72(1): pp. 109–118.

Schumpeter, J. A. (1934): “The theory of economic development: An inquiry into profits, capital, credit, interest, and the business cycle,” volume 55. Transaction Publisher.