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This paper investigates the relationship between product market competition and innovation. We find strong evidence of an inverted-U relationship using panel data. We develop a model where competition discourages laggard firms from innovating but encourages neck-and-neck firms to innovate. Together with the effect of competition on the equilibrium industry structure, these generate an inverted-U. Two additional predictions of the model-that the average technological distance between leaders and followers increases with competition, and that the inverted-U is steeper when industries are more neck-and-neck-are both supported by the data.

A MODEL OF GROWTH THROUGH CREATIVE DESTRUCTION A5STR.ACTThis paper develops a model based on Schumpeter's process of creative destruction. It departs from existing models of endogeneous growth in emphasizing obsolescence of old technologies induced by the accumulation of knowledge and the resulting process or industrial innovations. This has both positive and normative implications for growth. In positive terms, the prospect of a high level of research in the future can deter research today by threatening the fruits of that research with rapid obsolescence. In normative terms, obsolescence creates a negative externality from innovations, and hence a tendency for laissez-faire economies to generate too many innovations, i.e too much growth. This "business-stealing" effect is partly compensated by the fact that innovations tend to be too small under laissez-faire.The model possesses a unique balanced growth equilibrium in which the log of GNP follows a random walk with drift. The size of the drift is the average growth rate of the economy and it is endogeneous to the model ; in particular it depends on the size and likilihood of innovations resulting from research and also on the degree of market power available to an innovator. INTRODLJCIONThis paper presents a model of endogenous stochastic growth, based on Schuxnpecers idea of creative desiruction. We begin from the belief, supported by many empirical studies starting with Solow (1957), that a large proportion of economic growth in developed counthes is atthbutable to improvement in technology rather than the accumulation of capital. The paper models technological progress as occurring in the form of innovations, which in turn result from the activities of research firms.We depart from existing models of endogenous growth (Rorner, 1986(Rorner, , 1988and Lucas, 1988) in two fundamental respects. First, we emphasize the fact that technological progress creates losses as well as gains, by rendering obsolete old sidils, goods, markets, and manufacturing processes. This has both positive and normative implications for growth. In positive terms, the prospect of a high level of research in the future can deter research today by threatening the fruits of that research with rapid obsolescence. In normative terms, obsolescence creates a negative externality from innovations, and hence a tendency for laissez-faire to generate too much growth.Obsolescence does not fit well into existing models of endogenous growth. Those models have only positive externalities, in the form of technology spillovers, and thus tend to generate too little growth. The closest in spirit to our model is that of Romer (1988) allowing old goods to be displaced by the inuoduction of new goods, may eliminate growth in this nd of model (see Deneckere and Judd, 19861)..Our second departure is that we view the growth process as discontinuous. Existing models of endogenous growth do not produce a random end, unless exogenous technology shocks are added to the model, as is done by King and Rebelo (1988)...

This paper investigates the relationship between product market competition and innovation. We find strong evidence of an inverted-U relationship using panel data. We develop a model where competition discourages laggard firms from innovating but encourages neck-and-neck firms to innovate. Together with the effect of competition on the equilibrium industry structure, these generate an inverted-U. Two additional predictions of the model-that the average technological distance between leaders and followers increases with competition, and that the inverted-U is steeper when industries are more neck-and-neck-are both supported by the data.