Abstract

This paper examines the importance of competition in innovation and the growth of firms. We make use of the large-scale natural experiment of the shift from an economic system without competition to a market economy to shed light on the factors that influence innovation by firms and their subsequent growth, thereby alleviating problems due to non-random clustering of innovation opportunities in mature market economies. We find evidence that monopolies innovate less and have weaker growth than firms facing a minimum of rivalry. The presence of competitors has both a direct effect on performance, and an indirect effect, through improving the efficiency with which the rents from market power in product markets are utilised to undertake innovation. There is also some less clear-cut evidence of an 'inverted-U', namely that the presence of a few rivals is more conducive to performance than the presence of many competitors.