Competition And Innovation: The Inverted-U Relationship Revisited
The author re-examines the inverted-U relationship between competition and innovation (originally modeled and tested by Aghion et al. ) by using data from publicly traded manufacturing firms in the US. The author controls for the possible endogeneity of competition by using various measures of foreign competition as instruments. The author finds a positive relationship between competition (as measured by the inverse of markups) and innovation (as measured by citation-weighted patents). The positive relationship is robust to many alternative assumptions and specifications. To reconcile the positive relationship in the US data with the inverted-U relationship that Aghion et al.  find in the UK data, the author modifies their theoretical model and shows that the modified model can explain both positive and inverted-U relationships.