SOME CONCLUSIONS - Although the economic literature discussed above has led to opposing
views which makes it difficult to reach strong conclusions on the relationship between market structure and innovation, it is possible to make some general remarks. Gilbert identifies a few conditions under which the economic theory discussed above supports the proposition that competition, instead of monopoly, is more likely to benefit innovation. First, if intense competition in the old product exists, the pre-innovation profit of a firm will be lower which in turn increases its incentive to innovate, since it does not have a high and stable profit flow that it will forego by innovating (the escape-competition effect). Secondly, if the innovation makes the old technology obsolete, the monopolist’s gain from innovation does not exceed the gain to a new competitor.268 The innovation is such a major improvement that a new market is established on which the innovator will be a monopolist as the only provider of the new technology.269 The third factor that is of importance in Gilbert’s view is the extent to which the monopolist can price discriminate among consumers after innovating. It is more attractive for a monopolist to work on a new technology if it will be able to price discriminate by offering both its old and new product. However, if price discrimination is not likely, Arrow’s replacement effect suggests that a competitive market structure rather than a monopoly benefits innovation. Lastly, if market conditions make pre-emption unlikely for example due to the existence of alternative R&D paths that the incumbent cannot foreclose, a
265 P.A
GHION,N.BLOOM,R.BLUNDELL, et al., "Competition and Innovation: An Inverted-U Relationship", Quarterly Journal of Economics 2005, vol. 120, no. 2, (701), p. 701-728.
266
P.AGHION,R.BLUNDELL,R.GRIFFITH, et al., "The Effects of Entry on Incumbent Innovation and
Productivity", The Review of Economics and Statistics February 2009, vol. 91, no. 1, (20), p. 20. 267 J.G
ALLOWAY, "Driving Innovation: A Case for Targeted Competition Policy in Dynamic Markets ", World
Competition 2011, vol. 34, no. 1, (73), p. 79.
268 This is presupposing that the monopolist cannot innovate at a lower cost than the new competitor. 269
R.GILBERT, "Looking for Mr. Schumpeter. Where Are We in the Competition-Innovation Debate?" in A.B. JAFFE,J.LERNER AND S.STERN (eds.), Innovation Policy and the Economy, The MIT Press, 2006, (159), p. 168- 169 and R.J.GILBERT, "Competition and Innovation" in W.D.COLLINS (ed.), Issues in Competition Law and
Policy, Volume I, Chapter 24, American Bar Association Antitrust Section, 2008, (577), p. 22-23, available at
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monopolist will not have an incentive to innovate in order to pre-empt the market entry of rivals.270
SOME PRINCIPLES - Similarly, Baker has formulated four principles that relate the level of
innovation in an industry to the extent to which competition takes place in the market. The first principle states that competition in innovation, that is defined as ‘competition among
firms seeking to develop the same new product or process’ encourages innovation. According
to this principle, firms in a race to innovate try harder to win. The second principle entails that ‘competition among rivals producing an existing product encourages those firms to find ways
to lower costs, improve quality, or develop better products’. This is a translation of the
finding of Aghion et al. that investment in innovation may allow firms to escape competition. However, if firms do not expect to escape competition by innovating but rather believe to be subject to more competition, they have less incentive to innovate. This forms the third
principle. The fourth principle involves the incentive of a firm to pre-empt the entry of rivals. According to this principle, ‘a firm will have an extra incentive to innovate if in doing so it
can discourage potential rivals from investing in R&D’. In this situation, the firm not only
benefits from its investments by introducing new or better products, but also by discouraging potential rivals from innovating.271
INNOVATION INCENTIVES - The existence of incentives to innovate at the side of market
players is vital for innovation to take place. An innovation incentive can be defined as ‘the
difference in profit that a firm can earn if it invests in R&D compared to what it would earn if it did not invest’.272 Since the scope of an innovation incentive depends on many factors that sometimes have opposing effects, it is hard to predict how an incentive will be affected by a certain development or intervention, for example on the basis of competition law, in the market. Against the background of the economic theory, Gilbert has identified four factors that influence the existence of innovation incentives: (1) the profit that can be gained from innovation in the form of selling a new product, (2) the existing profit that is eliminated by innovating (Arrow’s replacement effect), (3) the reduction of competition that occurs when a firm is able to differentiate its products or lower its production costs by innovating (Aghion’s escape-the-competition effect) and (4) the possibility to pre-empt competition by deterring rivals from entering the market. As the incentive to pre-empt can offset Arrow’s replacement effect, the second and fourth factor point in opposite directions. The exact scope of the
innovation incentive depends on the extent to which each of the four factors are present in the specific technological and market conditions.273 For instance, robust intellectual property
270
R.J.GILBERT, "Competition and Innovation" in W.D.COLLINS (ed.), Issues in Competition Law and Policy, Volume I, Chapter 24, American Bar Association Antitrust Section, 2008, (577), p. 23, available at
http://eml.berkeley.edu/~gilbert/wp/competition_and_innovation.pdf. 271 J.B.B
AKER, "Beyond Schumpeter vs. Arrow: How Antitrust Fosters Innovation", Antitrust Law Journal 2007, vol. 74, no. 3, (575), p. 579-581.
272
R.GILBERT, "Looking for Mr. Schumpeter. Where Are We in the Competition-Innovation Debate?" in A.B. JAFFE,J.LERNER AND S.STERN (eds.), Innovation Policy and the Economy, The MIT Press, 2006, (159), p. 162. 273 R.J.G
ILBERT, "Competition and Innovation" in W.D.COLLINS (ed.), Issues in Competition Law and Policy, Volume I, Chapter 24, American Bar Association Antitrust Section, 2008, (577), p. 8-9, available at
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protection may increase the strength of the first factor, since an innovator will be better able to capture the benefits from introducing new products.274
EMPIRICAL RESEARCH - The economic theories put forward by Schumpeter, Arrow and others
have been tested in numerous empirical studies.275 Although early studies confirmed the Schumpeterian hypothesis that the level of innovation tends to be larger in concentrated industries, in later and more refined statistical analyses this observation did not hold true.276 Several problems can be identified from which the early empirical studies suffered such as failure to control for other factors that may influence innovation incentives and failure to take into account the differences in technological opportunities and appropriability across
industries.277 For reaching a reliable conclusion on the link between competition and innovation, the effect of competition has to be isolated. In some industries, technological possibilities may be greater or firms may have better guarantees that they are protected from competition after innovating because of, for example, broad and strong intellectual property rights.278 Although later studies including the inverted-U model of Aghion et al. have tried to address these problems, it remains difficult to control for differences in industry
characteristics and for factors other than competition that may affect innovation.279 According to Gilbert, an ideal way to test the effect of competition on innovation ‘would be a natural
experiment in which external and unforeseen events cause a discrete change in the extent of competition in an industry with no other consequences for other determinants of innovation, such as technological opportunity or appropriability’.280 However, in his view none of the available studies in the literature entirely isolate the influence of factors other than changes in
274 Gilbert also discusses the significance of distinctions between product and process innovations for the relationship between competition and innovation. See R.GILBERT, "Looking for Mr. Schumpeter. Where Are We in the Competition-Innovation Debate?" in A.B.JAFFE,J.LERNER AND S.STERN (eds.), Innovation Policy
and the Economy, The MIT Press, 2006, (159), p. 159-215.
275 An overview of the empirical studies that test the relationship between competition and innovation can be found in R.GILBERT, "Looking for Mr. Schumpeter. Where Are We in the Competition-Innovation Debate?" in A.B.JAFFE,J.LERNER AND S.STERN (eds.), Innovation Policy and the Economy, The MIT Press, 2006, (159), p. 188-189.
276 R.G
ILBERT, "Looking for Mr. Schumpeter. Where Are We in the Competition-Innovation Debate?" in A.B. JAFFE,J.LERNER AND S.STERN (eds.), Innovation Policy and the Economy, The MIT Press, 2006, (159), p. 190. 277
See R.GILBERT, "Looking for Mr. Schumpeter. Where Are We in the Competition-Innovation Debate?" in A.B.JAFFE,J.LERNER AND S.STERN (eds.), Innovation Policy and the Economy, The MIT Press, 2006, (159), p. 191-200.
278 J.B.B
AKER, "Beyond Schumpeter vs. Arrow: How Antitrust Fosters Innovation", Antitrust Law Journal 2007, vol. 74, no. 3, (575), p. 584.
279
See J.B.BAKER, "Beyond Schumpeter vs. Arrow: How Antitrust Fosters Innovation", Antitrust Law Journal 2007, vol. 74, no. 3, (575), p. 584-585.
280 R.G
ILBERT, "Looking for Mr. Schumpeter. Where Are We in the Competition-Innovation Debate?" in A.B. JAFFE,J.LERNER AND S.STERN (eds.), Innovation Policy and the Economy, The MIT Press, 2006, (159), p. 197- 199.
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competition.281 The empirical literature remains ambiguous and therefore it is difficult to make strong conclusions about the effect of competition on innovation.282
ATTEMPTS TO FIND A MIDDLE GROUND -Even though the economic and empirical literature on
the link between market structure and innovation is not conclusive, there have been attempts to find a middle ground between Schumpeter and Arrow as the two main schools of thought. Motta argued in this regard that an environment ‘where there exists some competition but also
high enough market power coming from the innovative activities, might be the most conducive to R&D output’.283 Another attempt to reconcile the divergent views in economic theory has been made by Shapiro who maintained that the perspectives of Schumpeter and Arrow are ‘fully compatible and mutually reinforcing’.284
In particular, he argued that there is no need for a universal theory of the relationship between competition and innovation as far as competition policy is concerned. To this end, he offered three principles on which
Schumpeter and Arrow converge in his view: (1) the contestability principle according to which the prospect of gaining or protecting profitable sales by providing greater value to customers spurs innovation; (2) the appropriability principle which states that increased appropriability spurs innovation; and (3) the synergies principle according to which combining complementary assets enhances innovation capabilities and thus spurs innovation.285 Following Shapiro, the views of Schumpeter and Arrow could be brought together by making a distinction between an ex-post and ex-ante perspective on innovation incentives. While Schumpeter focuses on the ex-post perspective by arguing that firms will only invest if they can expect to appropriate the benefits resulting from their innovations, Arrow focuses on the ex-ante perspective by asking himself what the best environment to promote innovation is and suggests that it is in a competitive environment that firms innovate more. Against this background, Director-General for Competition Laitenberger argued that ‘as long as competition policy does not negatively affect equitable appropriability – for
instance, as long as it respects IPRs – it will be compatible with both Arrow and Schumpeter’.286
NO GENERAL LINK - What can be concluded from the review of the economic theory and
empirical research on the interaction between competition and innovation is that there is no
281
See for a discussion of several studies in this regard, R.GILBERT, "Looking for Mr. Schumpeter. Where Are We in the Competition-Innovation Debate?" in A.B.JAFFE,J.LERNER AND S.STERN (eds.), Innovation Policy
and the Economy, The MIT Press, 2006, (159), p. 197-199 and R.J.GILBERT, "Competition and Innovation" in W.D.COLLINS (ed.), Issues in Competition Law and Policy, Volume I, Chapter 24, American Bar Association Antitrust Section, 2008, (577), p. 18-19, available at
http://eml.berkeley.edu/~gilbert/wp/competition_and_innovation.pdf. 282 R.G
ILBERT, "Looking for Mr. Schumpeter. Where Are We in the Competition-Innovation Debate?" in A.B. JAFFE,J.LERNER AND S.STERN (eds.), Innovation Policy and the Economy, The MIT Press, 2006, (159), p. 205- 206.
283 M.M
OTTA, Competition Policy. Theory and Practice, Cambridge University Press, 2004, p. 57. 284 C.S
HAPIRO, "Competition and Innovation: Did Arrow Hit the Bull's Eye?" in J.LERNER AND S.STERN (eds.),
The Rate and Direction of Inventive Activity Revisited, NBER, 2012, (361), p. 363.
285
C.SHAPIRO, "Competition and Innovation: Did Arrow Hit the Bull's Eye?" in J.LERNER AND S.STERN (eds.),
The Rate and Direction of Inventive Activity Revisited, NBER, 2012, (361), p. 364-365.
286 Speech Director-General for Competition Laitenberger, ‘Competition and Innovation’, CRA Annual Conference Brussels, 9 December 2015, p. 8, available at
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universal theory of the relationship between competition and innovation and, consequently, no optimal market structure for stimulating innovation across the economy or even within a specific industry sector.287 The economic and empirical literature does not provide support for a conclusion that monopoly is beneficial for innovation as Schumpeter put forward. At the same time, there is no support for the finding of Arrow that a competitive market structure favours innovation. Although a plea for a case-by-case assessment may not come as a surprise, it is still worth emphasising that no general conclusion can be made on the
appropriate way to relate innovation to market structure.288 The only general assumption that can be made for a sector is that there is room for competition enforcement in limited
circumstances. Because of the absence of a clear link between market structure and
innovation, the establishment of a competitive market in itself may not necessarily benefit the level of innovation in an industry. Nevertheless, it should also be accepted that competition policy can be essential for fostering innovation in certain circumstances.289