Competition, Imitation and Growth with Step-by-Step Innovation
GAICIL Insights
The classic growth models said competition kills innovation.1 They were modeling the wrong firms. Competition, Imitation and Growth with Step-by-Step Innovation, by Philippe Aghion, Christopher Harris, Peter Howitt and John Vickers, builds an endogenous growth model in which technological laggards must first catch up with the leading-edge technology before battling for leadership.
Earlier models typically assumed innovations come from outsider firms that earn no rents if they fail and become monopolists if they succeed. There, more competition cuts the rents of successful innovators and dampens incentives. Easier imitation and weaker patent protection do the same by shortening the expected duration of rents.
The authors change the question. The incentive to do research depends on incremental rents: the gap between the rents of a successful innovator and an unsuccessful one. Most innovative activity occurs within industries with more than one firm and within existing firms already earning rents. Competition can raise incremental rents by squeezing the profits of firms that fail to innovate. Losing gets more painful, so winning gets more valuable.
Two findings follow. First, the usual negative effect of more intense competition on innovation is almost always outweighed by the stronger incentive to innovate in order to escape competition, so product market competition has a positive effect on growth. Second, a little imitation is almost always growth-enhancing, because it promotes more frequent neck-and-neck competition, but too much imitation is unambiguously growth-reducing. The dose makes the medicine.
Competition policy and patent policy thus play complementary roles. Competition policy strengthens the incentive to escape competition; patent policy limits excessive imitation that would erode the returns to innovation. Growth needs both levers pulled together.
Here is where the paper meets the present. AI markets look like this model in motion. Leaders and followers compete step by step, with laggards seeking to catch up before contending for leadership. The escape-competition effect suggests intense rivalry among close rivals drives rapid innovation, a dynamic visible where several firms compete closely to build more capable models. A tight race is a fast race.
Imitation is AI's double-edged sword. Knowledge spreads quickly through publications, open models and researcher movement. Moderate imitation lets followers catch up and keeps competition neck and neck, stimulating innovation. Too much imitation could cut returns to innovation and discourage investment at the frontier. Open diffusion is a growth tonic up to a point, and past it the frontier starves.
Governance follows from the complementarity. Competition policy can keep AI markets contestable, sustaining escape competition. Intellectual property policy can balance diffusion against protecting the returns that motivate frontier research. Designing them jointly matters; tuning one while ignoring the other risks undoing the gain.
Market structure matters for the race. Leaders must keep innovating to stay ahead, and followers have reasons to catch up. Structures with several firms close to the frontier may generate more innovation than one dominated by a single far-ahead leader. A runaway leader faces little pressure, and distant followers see little hope.
On policy, competition is generally good for growth when innovation proceeds step by step, and moderate imitation helps. Policies should promote competition while ensuring imitation never becomes so easy that it undermines the incentive to innovate.
Seen whole, the paper's message is plain: competition and moderate imitation enhance growth by pushing firms to innovate to escape competition. Too much imitation reduces growth, which gives competition and patent policy complementary roles. Applied to AI, these insights can sustain the competitive race at the technological frontier.
For AI policy debates, the sting is this: the right metric is the distance between leader and followers. If rivals stay neck and neck, competition is doing its work; if one firm pulls far ahead, or if copying becomes costless, the step-by-step race that drives progress slows from both ends.
Introduction
Is more intense product market competition and imitation good or bad for growth? This question is addressed in the context of an endogenous growth model with “step-by-step” innovations, in which technological laggards must first catch up with the leading-edge technology before battling for technological leadership in the future. In contrast to earlier Schumpeterian models in which innovations are always made by outsider firms who earn no rents if they fail to innovate and become monopolies if they do innovate, here we find: first, that the usual Schumpeterian effect of more intense product market competition (PMC) is almost always outweighed by the increased incentive for firms to innovate in order to escape competition, so that PMC has a positive effect on growth; second, that a little imitation is almost always growth-enhancing, as it promotes more frequent neck-and-neck competition, but too much imitation is unambiguously growth-reducing. The model thus points to complementary roles for competition (anti-trust) policy and patent policy.
Takeaway
We have already summarized our results in the introduction to the paper.1
Our investigations of this extension have not so far changed any of the conclusions reported above. A third extension is to consider the case of non-unit elastic industry demand functions. The conclusion that an increase in α is almost always growth-enhancing, which came out of both our asymptotic expansions and our simulations, should, by continuity, carry over to the case where demand functions are almost unit-elastic. Furthermore, preliminary investigation of the case where industry demand functions are more than unit elastic , confirms the inverted U-shaped effect of α on g which we had already found in the basic unit-elastic case analyzed above. Indeed, the greater the elasticity of industry demand, the greater the incentive response of a neck-and-neck firm to an increase in α: innovating will allow a neck-and-neck firm not only to move ahead of its competitor in the same industry, but also to steal more business from other sectors in the economy.
This prediction seems to be confirmed by recent empirical work by Blundell et al. (1995), which finds that the correlation between PMC and growth is more positive in more concentrated industries.2 More generally, whether the positive correlation between PMC and growth can be explained more convincingly by the “escape competition” effect analyzed in this paper than by agency considerations or mobility effects remains the subject of further empirical research. a corresponding effect on aggregate growth which again should be positive or inverted U-shaped.
See Nickell et al. (1997), and Aghion et al. (1999).3
Notes
- Philippe Aghion et al., Competition, Imitation and Growth with Step-by-Step Innovation, 68 Rev. Econ. Stud. 467 (2001), https://doi.org/10.1111/1467-937x.00177. Takeaway source: Concluding remarks, reproduced from a free author or repository copy. ↩
- Blundell, R., R. Griffith, and J. Van Reenen (1995): “Dynamic Count Data Models of Technological Innovation.” Economic Journal, 105, pp. 333— 344.. ↩
- Nickell, Stephen, Daphne Nicolitsas, and Neil Dryden (1997): “What Makes Firms Perform Well?” European Economic Review 41: pp. 783-96.. ↩
Cite as: Philippe Aghion et al., Competition, Imitation and Growth with Step-by-Step Innovation, 68 Rev. Econ. Stud. 467 (2001), https://doi.org/10.1111/1467-937x.00177
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