Unfortunately, many economists seem to be stuck in a well- traveled and largely irrelevant debate, now half a century old, as to what form of market structure favors innovation, labeling this as the “Schumpeterian” debate. Regrettably, this is all that many have absorbed from the rich work of Schumpeter, the Austrian School, and extensive development in behavioral and evolutionary eco- nomics. This so-called “Schumpeterian debate” casts Schumpeter too narrowly and is not of much interest any more. However, it can still bog down discussions about competition policy and innovation.
A more careful reading of Schumpeter will reveal at least three Schumpeterian propositions relevant to antitrust policy. (The ﬁrst two are discussed in this section, the third in the next.) The ﬁrst proposition relates to the impact of market structure on inno- vation. On this topic, Schumpeter himself articulated conﬂicting and inconsistent perspectives. In The Theory of Economic Development (1911) he spoke of the virtues of competition fueled by entre- preneurs and small enterprises. By the time he wrote Capitalism, Socialism, and Democracy (1942), Schumpeter’s revised (second) proposition was that large ﬁrms with monopoly power are nec- essary to support innovation. This transformation was no doubt in part a reﬂection of the transformation that had occurred with respect to the principal sources of innovation in the American economy.
So with respect to the impact of market structure on innovation, Schumpeter seems to have maintained two almost diametrically opposite positions. One can call his ﬁrst position Schumpeter I, and the second position Schumpeter II.
Schumpeter I is perhaps more appealing today than Schum- peter II. Indeed, I believe that the debate over whether to favor competition over monopoly (as the market structure most likely to advance innovation) was won long ago in favor of some form of rivalry/competition.
However, the line of causation which is most commonly dis- cussed runs only from competition to innovation. Indeed, as noted by the FTC: “competition can stimulate innovation. Competition amongst ﬁrms can spur the invention of new or better products or more efﬁcient processes . . . ”.1 While this is undoubtedly correct, it does not recognize that innovation may impact competition and market structure. Nor does it suggest what type of market structure is desirable—only that competition can drive innovation.
Unfortunately, we don’t appear to have found a great deal of evidence that market concentration has a statistically signiﬁcant impact on innovation, despite 50 years of research. The main take away is probably that this is not a useful framing of the problem, in that market concentration alone doesn’t stack up even theoretically (let alone empirically) as a major determinant of innovation.
In short, framing competition issues in terms of monopoly versus competition appears to have been unhelpful, at minimum incon- clusive. Rivalry matters, but market concentration doesn’t neces- sarily determine rivalry.
In brieﬂy reviewing the theory, one can note that some industrial organization theories suggest that innovation is bound to decline with increasing competition, since the monopoly rents for new entrants will decline with increasing competition (Dasgupta and Stiglitz, 1980; Kamien and Schwartz, 1982).
Other studies, following Arrow (1962), hypothesize a positive relationship between competition and innovation. But Arrow sets aide the appropriability problem (i.e. how to capture value from innovation) and posited a perfect property right in the information underlying a speciﬁc production technique.
One can perhaps interpret Arrow’s property right as a clearly speciﬁed and costlessly enforceable patent of inﬁnite duration. The principal focus of Arrow is on how the (pre-invention) structure of the output market affects the gain from invention. Competition wins out because competitive output is larger than with monopoly. Hence, a given amount of unit costs reduction is more valuable if the market is initially competitive. Protected by a perfect patent, the inventor simply licenses the invention at a whisker below the cost saving that the invention makes possible. Put differently, com- petition will win out and advance innovation when the business environment is characterized by what I call elsewhere a strong appropriability regime (Teece, 1986a).
Absent strong appropriability, the presumption that (perfect) competition is superior to alternative arrangements cannot be built on Arrow (1962). In fact, it is important to note that despite how Arrow’s paper is usually interpreted (to claim that competition spurs innovation), Arrow’s general position in his writings is, much like Schumpeter, that competitive markets provided inadequate incentives to innovate.
As Sidney Winter points out, Arrow’s analysis also sidesteps busi- ness model choices (Winter, 2006). The producer and the inventor are one in the same.
Of course, one must also recognize that business (model) inno- vation is important to economic welfare, along with technological innovation. But the economics literature (theoretical or empirical) does not seem to address whether market structure is important to this type of innovation.
Empirical evidence is equally murky. Cohen and Levin (1989) review the literature and conclude that there isn’t a strong linkage between market concentration and innovation. The endogeneity of market structure is perhaps one reason why a robust statistical relationship between concentration and innovation is yet to be found. Nor is there any signiﬁcant relationship between market concentration and proﬁtability. As Joskow (1975) notes, “we have spent too much time calculating too many kinds of concentration ratios and running too many regressions of these against proﬁt ﬁgures of questionable validity” (p. 278).
Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.