Competition, Market Selection and Growth

Abstract

We study the effect of the competitive selection process on the economy's rate of growth. In an extension of standard quality-ladder models of endogenous growth, we allow for the possibility that in each period several asymmetric firms (representing an endogenously determined number of past innovators) may be simultaneously active in an industry. Stronger competitive pressure then has conflicting effects on the incentive to innovate, lowering prices but also selecting the more efficient firms. We show that the market selection effect of competition always increases the incentive to innovate and find circumstances in which it can outweigh the traditional negative effect of lower prices.One of the many reasons why economists praise competition is that it improves the process of output reallocation between producers, selecting the more efficient firms and weeding out the less efficient. This competitive selection process is especially important in growing economies, where productivity changes continuously with technical progress. In the growth literature, most Schumpeterian models of endogenous growth posit competition so intense that only the most productive firm is active in each industry at any time, implying that there is no room for further improvement in the process of market selection. But there is ample empirical evidence of micro-level heterogeneity in productivity across firms, which suggests that in real life competition may not be as intense.If this is so, an increase in competitive pressure can still improve the process of market selection. This is certainly good for static efficiency but what effect does it have on the incentive to innovate and hence the growth rate of the economy? Our thesis is that stronger competitive selection is also good for growth and its positive effect can be great enough to outweigh the traditional negative Schumpeterian effect. Thus, our analysis can help to explain the positive or uncertain relationship between competition and growth found in the empirical literature. 1 To demonstrate our results, we extend standard quality-ladder models of endogenous growth to allow for the possibility that several asymmetric firms (representing an endogenously determined number of successive innovators) can be active in an industry at the same time. In early Schumpeterian models, it is an equilibrium property that the technological leader should be the sole active firm. This follows from the postulate that innovations are drastic, or else firms compete a la Bertrand. 2 Our extension is to assume that innovations are non-drastic and that firms compete a la Cournot. (We also use a conjectural-variations reduced-form model that encompasses * We are grateful to three anonymous referees and Editor Antonio Ciccone for useful comments and suggestions on previous versions of this article. We also benefited from comments by

Inflation and economic growth in a Schumpeterian model with endogenous entry of heterogeneous firms

“…We substitute (16) and the R&D condition (11) into (A7) to derive 16 We achieve this by applying integration by parts to…”

“…We can determine using the R&D condition v e t = (1 + i) Q (1 )= t , where the balanced-growth value of v e t is given by v e t = e t =( +~ 1= ) ~ 1= Q (1 )= t using (15) and the Euler equation. Then, substituting (16) into the R&D condition, we obtain (1 )…”

Board of Director Collusion, Managerial Incentives and Firm Values

“…An increase in market size increases demand of firm i and hence the manager's incentives to cut costs; moreover, it leads to a greater pay-for-performance sensitivity, which further increases managerial effort. A change in t leads to a business stealing effect 13 , a size effect 14 and to a competition-fordemand effect. Akin to Raith (2003), the former two effects cancel each other, and thus the presence of the third effect leads to a positive relationship between product substitutability and managerial effort.…”

“…12 In the symmetric equilibrium, firm demand is d i = m n . 13 The lower t is, the more elastic demand becomes, that is, price reductions lead to larger demand increases and hence to greater incentives to cut costs.…”

Entry and Incumbent Innovation

“…More specifically, they show that a higher entry threat increases the incumbent's investment when the firm is initially close to the technological frontier, due to the escape-entry effect; it is the other way round if the incumbent is further behind the 3 See, for example, Lee and Wild (1980) vs. Delbono andDenicolo (1991), Gilbert andSunshine (1995), Belleflamme and Vergari (2006), Sacco and Schmutzler (2007), Schmutzler (2007), Zanchettin (2008), andVives (2008). For surveys, see Aghion and Griffith (2005) or Gilbert (2006).…”