This outstanding short book offers a serious attempt to provide a unified and coherent account of the effect competition policy and deregulated entry in product markets has on economic growth. It takes the form of a dialogue between an applied theorist calling on "Schumpeterian growth" models and a microeconometrician employing new techniques to gauge competition and entry. In each chapter, theoretical models are systematically confronted with empirical data, which either invalidates the models or suggests changes in the modeling strategy. Aghion and Griffith note a fundamental divorce between theorists and empiricists who previously worked on these questions. On one hand, existing models in industrial organization or new growth economics all predict a negative effect of competition in product markets on innovation and growth: namely, that product market competitionis bad for growth because it reduces the monopoly rents that reward successful innovators. On the other hand, common wisdom and recent empirical studies point to a positive effect of this kind of competition on productivity growth. To reconcile theory and evidence, the authors distinguish between pre- and post-innovation rents, and propose that innovation may be a way to escape competition, an idea that they confront with microeconomic data.
The main theoretical contribution, formalizes entry of firms as an exogenous process and shows that a higher probability of entry induces incumbent leaders with technology close to the frontier to invest more in innovation. This results matches empirical evidence on the impact of entry on TFP growth, as shown also by P. Aghion, N. Bloom, R. Blundell, R. Griffith and P. Howitt ( Competition and Innovation: An Inverted-U Relationship, 2005, Quartely Journal of Economics).
According to Aghion and Griffith, their results are somewhat in contrast with recent theories of innovation by leaders according to which there would be "a specificity of innovative markets with respect to competition." These theories would see "the role of antitrust action in innovative sectors as one of counteracting incumbent firms that try to prevent innovation by new entrants by issuing and accumulating (unjustified) patents. In other words, antitrust action should focus on fostering competition for the market, but not so much on increasing competition in the market, since this would reduce innovation incentives by reducing rents. In innovative markets where incumbents innovate, antitrust action should be restrained so as not to stamp out monopoly power in such markets." On the contrary, the research by Aghion and Griffith would suggest that "stimulating competition in the market, especially in sectors that are close to the corresponding world frontier and/or where incumbent innovators are neck-and-neck, can also foster competition for the market through the escape competition effect. Incumbent firms innovate precisely as a response to increased product market competition or to increased entry threat." We are not sure that this distinction between alternative approaches is usefull, since the new theories of market leadership emphasize the beneficial effect of free entry in both innovation markets and product markets while the Aghion-Griffith analysis does not endogenize entry and so the relation between competition in the market for innovations and growth Hence, it does not even endogenize the incentives by the incumbent leaders to invest in R&D. Nevertheless, the theoretical and empirical work summarized in this book represents a major effort in understanding the relation between product market competition and growth.
