Standing on the Shoulders of Midgets: Dominant Firms and Innovation Incentives

I develop a dynamic innovation model with three important features: (a) asymmetry between large and small firms (“giants” and “midgets”); (b) technology transfer by acquisition; and (c) the distinction between gradual innovation (i.e., within a certain “paradigm”) and disruptive innovation (i.e., that which induces a new paradigm). I provide conditions such that (a) greater asymmetry between giant and midget decreases incremental innovation but increases disruptive innovation; and (b) allowing for technology transfer increases incremental innovation but decreases disruptive innovation. Paganelli-Bull Professor of Economics and International Business, Stern School of Business, New York University; and Research Fellow, CEPR; [email protected]. Preliminary drafts of this paper were presented at Queens University and at the MaCCI Summer Institute. At both venues I received useful comments and suggestions, for which I am grateful.