QuestionIs competition or monopoly more innovative?
Hopes&Fears answers questions with the help of people who know what they're talking about. Today, we ask economists whether a market of one firm or many provides the ideal conditions for innovation.
Econ 101 teaches us that competition is both an "ideal" and "default" state, resulting in a perfect equilibrium where supply meets demand. According to PayPal overlord Peter Thiel, such logic is myopic, since competitive firms are too busy scrounging for their day-to-day survival to think about effecting any sort of widespread, radical change.
Thiel theorizes that the concentration of resources under monopoly provides the greatest incentive to innovate in terms of spending on things like research and development, as well as budgeting for other non-monetary factors such as the wellbeing of its employees, the satisfaction of its customers and its broader social and ecological impact on the world. So strongly does he feel about the topic at hand that an essay he published last year in The Wall Street Journal was titled "Competition is for Losers." Naturally, the "losers" beg to differ, arguing that monopoly is a handicap to innovation since it tends toward economic complacency. After all, once you've cornered the market, what else is left? Monopoly already gets a bad rap: it's held to be restrictive for consumers where both prices and information are concerned. Add to that the evidence that mergers often end in disaster for the mergée, and Thiel's theory seems even more problematic.
We asked economists whether a monopolistic or competitive system was more conducive to innovation.
Assistant Professor, Department of Economics, Columbia University
As John Maynard Keynes said: "Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist." In this case, Thiel's supposedly novel and controversial idea that a monopolistic market is more innovative than a competitive market is commonly attributed to Joseph Schumpeter in his 1942 book Capitalism, Socialism, and Democracy. The alternative, that competition produces more innovation than monopoly, is generally credited to Kenneth Arrow in his 1962 paper "Economic Welfare and the Allocation of Resources for Invention." (Later work by Frederic M. Scherer in the 1960s would put forth the theory that there was an innovation-maximizing level of competition.)
The idea is: with too much competition there would not be sufficient incentives to innovate, and without enough competition the dominant firm would rest on its laurels rather than develop new products and technologies. It is worth noting that sometimes competition comes not from another firm, but from your own existing products. For example, Microsoft can (and did) argue that Windows 98 faced strong competition from Windows 95; and Apple's biggest obstacle to the adoption of the IPhone 6S is probably the IPhone 6.
The truth is that like many things in economics, "it depends." It isn't that we don't have predictions, but rather these are empirical questions. Recent work by Brett Gordon (Kellogg School of Management, Northwestern University) and Ron Goettler (Simon Business School, University of Rochester) examined whether or not the presence of AMD caused Intel to innovate their central processing units (CPUs) more or less than they would have absent the competition. They find that Intel would have innovated more as a monopoly, however, with an important caveat: even though Intel might have been more innovative, most consumers were better off with slightly less innovation and the stronger price competition that AMD brought to the marketplace.
As another example, prior to 2006, the market for liquid crystal displays (LCDs) was widely known to have engaged in collusion and relatively slow innovation. The period that followed was characterized by large amounts of innovation and cutthroat price competition. Displays went from very expensive 14-inch laptop screens to 60-inch HDTVs in only a few years and prices fell more than 80%. This competition resulting in innovation was great for consumers, but the firms in the industry lost around $15 Billion.
Austrian-American economist Joseph Schumpeter was the first to propose a pro-monopolistic view of innovation. He argued that the firm that captured the lion's share of positive externalities would have the most incentive to innovate moving forward. Schumpeter aligned innovation with entrepreneurship, distinguishing between "replicative" entrepreneurs, who start ventures based on existing business models, and "innovative" entrepreneurs, who upset, or in modern techspeak, "disrupt," the standard way of doing things. According to the Schumpeterian school, when a firm debuts an innovative product, technology, or business strategy, others rush to adopt it, giving rise to inevitable copycats and driving down profit margins to unsustainable levels, which in turn provides the impetus for future innovation. He coined the term "creative desctruction" to describe how innovative forces move through the business cycle.
Professor, Department of Economics, Columbia University; CEO, Global Thermostat
What's more innovative is a mixture of the two.
In reality, neither monopoly nor competition make sense on their own. A monopoly would tend to overshoot and defeat its purpose. Same with competition. I am more interested in combining competition and collaboration. It makes more sense, and perhaps it is more innovative than each on its own.
But is it possible to combine monopoly and competition? Certainly: monopoly in some traits, competition in others. Monopoly to a certain extent and beyond that competition. You get the drift.
Professor, Economics and International Development, London School of Economics
Economists hold opposing views on this, and there's nothing particularly unconventional, either, about viewing monopoly to be conducive to innovation. All thinking on how it is a regime of strong intellectual property rights that provides incentive for invention and research, in effect, subscribes to the idea that it is excess monopoly rents that finance creativity.
Those arguing that competitive markets are what drive progress, whether they realise it or not, argue against a line of thinking that goes from Joseph Schumpeter and creative destruction all the way to modern views on endogenous growth.
On the other hand, of course, sanctioning monopolies does screw over ordinary people who want affordable access to pharmaceuticals, algorithms, and ideas.
Assistant Professor, Economics, University of Michigan
The short answer to the question is, "Who knows?" The tradeoffs are clear from the debate. What is less clear is the quantitative balance between these forces in any given situation.
An important point to make is that competition and monopoly do not exist in a vacuum. Public policies can alter the incentives to innovate in a way that decouples the rewards to innovation from power in the product market. For example, you could conduct innovation tournaments where the participants agree to forgo patenting their innovations for a chance to win a prize. Make the prize big enough and you can get as much innovation as you want, all without market power over the product. To be sure, such a solution generates its own inefficiencies and problems, and I am not advocating a general move toward this system for all types of innovation. I am just pointing out that, at least in principle and for some areas, we can eliminate this linkage between the rewards to innovation and market power.
Ph.D. Candidate in Economics, New York University
This point is not made nearly enough: it's important to make a distinction between "economists think" and "an introductory economics textbook says." It's like taking the syllabus for American Literature 101 as being the encompassing representation of American literature. There are plenty of Industrial Organisation economists like Petra Moser and Luis Cabral (full disclosure: they're in my department) who are not looking at innovation through the reductionist lens of "competition vs. monopoly." This isn't to say that market structure is not important, but rather that we've developed more nuanced frameworks for the problem.
There is some logic to Thiel's suggestion: he claims that monopolies that don't have to worry about competition can spend more resources coming up with new ideas and less on fending off competitors. This makes some intuitive sense. However, it assumes that the two options are mutually exclusive: you can either fend off potential competitors or engage in innovation. In reality, many firms actually innovate in order to contest with competitors. Think of the auto-industry in the 20th century: firms in different countries had to continuously innovate their production and/or management process in order to compete with one another.
Another issue that complicates matters is that for a given industry, the innovation process and market structure may not be independent. For example, they may both be jointly determined by the people who are choosing to go into those industries. Suppose you're a person with not very much capital and not very much innovative ability, and you're deciding whether to go into the electric car industry or the bread making industry. Clearly, you're going to want to make bread—you don't have the skills or resources to make electric cars. And you're also going to have a lot of competitors because there are just many more people who are in your boat.
On the other hand, if you've got a lot of resources and are highly innovative, you probably want to try for the electric car. You're going to have a lot less competitors than the bread maker just because there aren't that many people in the economy who are in your position. So, on the outside, while it looks like more competitive industries are less innovative, it's really because people have self-selected into industries based on their innovative ability. We can't say that innovation will happen in the bread industry if we just made it into a giant monopoly, because innovation is actually caused by something else—the presence of innovative individuals in the industry—and not the market structure of industry.