Do Competitive Markets Stimulate Innovation? An Empirical Analysis Based on Japanese Manufacturing Industry Data -

This paper empirically examines the effect of market competition – measured either by the Herfindahl Index or the Lerner Index – on productivity growth and R&D intensity using micro data for Japan’s manufacturing sector. We found evidence of an inverted U-shaped relationship between competition and innovation when we use the Herfindahl Index as a measure of competition in the market. In addition, we examined the effect of new entrants on the innovative activity of incumbents. The results of our estimation using a regulation index as our measure of entry barriers suggest that the effect on incumbents’ TFP growth depends on their technology level. When incumbents’ technology level is close to the technology frontier in their industry, competition from new entrants induces these firms to make efforts to increase their productivity in order to escape from competition.