Competition and Innovation - Microeconometric Evidence using Finnish Data

The relationship between product market competition (PMC) and innovative activity has attracted the attention of many economists lately. In this study we elaborate the theory of Aghion et al. (1997, 2001) of an inverted-U relationship between competition and innovations. We provide a theoretical prediction of a complementary relationship between the incentive effects of PMC and R&D subsidies. We empirically test our complementarity prediction and that of an inverted-U relationship using Finnish firm level data. Our results suggest that the inverted-U relationship is fairly robust to all our innovation measures. We also find that the inverted-U relationship tends to be steeper when also direct R&D subsidies are considered. This result suggests that there exists complementarity between competition and R&D subsidies.