Looking for Mr. Schumpeter: Where Are We in the Competition--Innovation Debate?

The effect of competition on innovation incentives has been a controversial subject in economics since Joseph Schumpeter advanced the theory that competitive markets are not necessarily the most effective organizations to promote innovation. The incentive to innovate is the difference in profit that a firm can earn if it invests in research and development compared to what it would earn if it did not invest. The concept is straightforward, yet differences in market structure, the characteristics of innovations, and the dynamics of discovery lead to seemingly endless variations in the theoretical relationship between competition and expenditures on research and development or the outputs of research and development (R&D). This paper surveys the economic theory of innovation, focusing on market structure and its relationship to competition, the distinction between product and process innovations, and the role of exclusive and nonexclusive rights to innovation, and draws conclusions from the different models. Exclusive rights generally lead to greater innovation incentives in more competitive markets, while nonexclusive rights generally lead to the opposite conclusion, although there are important exceptions. The paper reviews the large literature on empirical studies of innovation and finds some support for the predictions of the theory.