Competition and Innovation: Did Arrow Hit the Bull’s Eye?

Article Source: In The Rate and Direction of Inventive Activity Revisited, Josh Lerner and Scott Stern, eds., Chicago: University of Chicago Press, 2012, pp. 361-404
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This chapter discusses the relationship between competition policy and the rate of innovation by firms.


Policy Relevance:

Innovation should proceed in a market proportionate to the extent that multiple firms are competing to win future profits.


Key Takeaways:
  • Celebrated economists Kenneth Arrow and Joseph Schumpeter suggested, in varying formulations, that commercial innovation results from firms competing in a market to deliver new goods and capture future profits.
  • The author suggests three principles to explain firms’ decisions to pursue innovation.
    • The prospect of increasing future profits by providing greater value to consumers spurs innovation by firms.
    • When the possibility of controlling the benefits of an innovation is greater, firms are more likely to innovate.
    • Firms are more likely to innovate when their existing assets make innovation in a particular area easier.
  • The relationship between competition policy—the extent to which competitors are permitted to merge and coordinate activity—and innovation is complicated and delicate.
    • It is impossible to say without more information that any merger between large competitors is likely to decrease innovation.
  • However, a general principle may be claimed: as long as multiple firms are competing with one another, it is likely that a market will experience innovations.



Carl Shapiro

About Carl Shapiro

Carl Shapiro is the Transamerica Professor of Business Strategy at the Haas School of Business, and Professor of Economics in the Economics Department, at the University of California at Berkeley. His current research interests include antitrust economics, intellectual property and licensing, patent policy, product standards and compatibility, and the economics of networks and interconnection.