The relation between competition and innovation is theoretically ambiguous. On the one hand, as Schumpeter pointed out, having market power allows you to recover rents from new product sales, so you might expect monopolies to innovate more. On the other hand, innovation is costly, so without competitive pressure, you may simply rest on your laurels and keep selling your old product.
Goettler and Gordon, in a recent JPE, use the Intel/AMD microprocessor competition to investigate this issue. Innovation is easy to measure here – we simply look at the processor speed at the frontier for each firm, and avoid any messy issues about the difference between patented inventions and “actual” inventions. We can also track for over a decade the price differences in each firm’s top chips, the speed differences, and the response. The market is also for all practical purposes a duopoly with very little attempted entry. Computers possess another interesting property, in that they are durable goods. Past products compete with future sales. You may wish to keep prices high when you have market power this period in order not to cannibalize future sales if you expect a good innovation to appear next period for which you can charge even higher prices. Many sectors of the economy involve durable goods, of course.
The authors use a simple model to estimate consumer preferences in a structural model with spillovers (it is harder to push the frontier than to catch up). They find that, if Intel had a monopoly, innovation would have been 4% faster, but consumer surplus would have been 4% lower due to the higher prices charged by Intel, which is the standard Schumpeterian tradeoff. They find consumer surplus is maximized in a world where Intel has some anticompetitive power, though not monopoly power. The reason is that monopoly firms in durable goods markets still need to innovate because of competition with their old products, whereas duopolists can only earn rents to cover R&D costs if the two firms are selling different technologies. There are a number of interesting comparative statics as well. If spillovers are nonexistent, then the two firms race until one has a sufficiently large technological lead, at which point the other firm gives up, and no more innovation takes place, while if spillovers are large, the returns to each firm from doing R&D are low. In both cases, monopolists in a durable goods market innovate more. If spillovers are of an intermediate level, then duopolists will innovate more. As the authors note, “such variation might be one reason cross-industry studies have difficulty identifying robust relationships.”
The estimation involves some technical difficulties which may interest the Pakes-style IO readers. I am not an IO guy myself, so perhaps a reader can comment as to the more general style of this sort of paper. While I find the theory interesting, and am impressed by the difficulty of the empirical estimation, what exactly is the value of this sort of estimation? We know from theory the important qualitative tradeoffs. The style of estimation here can really only be done ex-post – the methods here could not be used, for example, to identify contemporaneously whether a anticompetitive behavior in a particularly durable goods industry is harmful for social welfare. I don’t mean to single this paper out, as this comment applies to a huge number of IO articles.
www.columbia.edu/~brg2114/files/dynduo.pdf (Final working paper)