The Moorish Wanderer

Markets, Innovation and Competition

Posted in Dismal Economics, Read & Heard, The Wanderer, Wandering Thoughts by Zouhair ABH on July 4, 2009

To quote Immanuel Wallerstein ‘Only a monopoly could pursue innovation (as a way to secure and expand its rent)’.

Though this statement is purely abstract, many examples come to mind when it is about innovation : apart from Edison-like geniuses, market innoation comes from large, oligopolistic or monopolistic structures : Apple with its Ipods and Iphones, Microsoft with Window and Internet browser (Albeit threatened by newcomers)…

The sum of examples is too large to be presented in length. One the other hand, economists from the dominant stream advocate strongly the idea that only free markets could bring about wealth, well-being and subsequently innovation (as part of the positivist ‘progressivism’ competition makes shared among agents)The main issue, therefore, is an attempt to find out about the various relations markets, innovation and competition have with each other : Could market competition encourage innovation ? How can innovation be measured in an economy ? what changes does innovation make within market structures ? The present article will present (or at least will try to) a proper definition of innovation, as a first step to understand mechanisms behind market changes. Secondly the readers will get acquainted with various theories contradicting the previous thesis, essentially on the point of competition. historical evidence shows the large role monopolies assumed in the global innovation, throughout human history. Finally, One will show that, though competition is for innovation to emerge, monopolies store undeniable advantages in controlling and improving it.

When an economist presents the free market as beneficial for innovation, they have in mind the following reasoning : an individual firm makes profits when its marginal cost is below the market price (one assumes the firm operating in a pure and perfect competitive market). Innovation intervenes when a firm makes a ‘discovery’, namely, a new combination of factors of production that produces more output for the same amount of input. In that sense, innovation is nothing more than a new combination of Labour and Capital, that increases significantly their marginal productivity.

So, a firm in a competitive market has a strong incentive to innovate, in order ot outsmart their competitors, and to increase its share of profits. In the short term, consumers benefit from competition, as the quality of goods improves (thanks to a better combination of means of production) at the same price, or even lower. In that sense, a free and competitive market presents all the incentives for companies to innovate, at least for the short run, since their innovation combinations -as a knowledge/information- are bound to be known to the market (fluid and transparency assumptions hold) and therefore neutralising their initial advantage. The theory seems perfect. Perhaps too perfect, as the real world differs significantly from the one pure microeconomics builds.

Game theory, as well as actual corporate behaviour tend to be more accurate in dealing with the innovation issue : a famous economist, H. Varian, wrote an article about network and high-tech economics, an article one should look at very closely : in an innovative market, two variables tend to contradict some of the important assumptions of free markets theories : transparency and fluid information.

A firm has the choice (or not) to undertake R&D studies, a decision that could cost a certain amount of money. As a rational agent, the firm has to guarantee sizeable returns over this investment : returns of investment have to outbalance their initial cost. Firms could for instance, develop some kind of restriction to the use of their innovative goods : Microsoft protects its software and forbids their uses to get to the original code-source (namely, the very heart of the software, which could be altered). Patents could also guarantee a rent to the innovative firm, by protecting its innovation. Those two pattenrs of behaviour contradict indeed the very heart of free and competitive markets : free information.

Another way of looking at the matter would be the ‘free rider’ theory : in a relatively open market, a firm could just wait for innnovation to ‘pop’ and grab it. The free rider firm would be actually happy to get a small but stable rent on the market, by adopting a ‘follower strategy’. In that case, and if all firms were to follow the same reasoning, no innovation would be expected.  In a monopoly though, things are different : as many economists put the stress on it, a competitive monopolistic market could be innovative, but to make sure that no potential newcommer would get into the market. In that sense, innovation works as a barrier to entry. Because monopolies do not bring maximum social utility, they are actively denounced by economists. The plain fact of the matter is, Innovation IS more effective under monopoly situation thant in competitive markets pattern.

The stumbling block in this issue is without doubt the treatment of information. Should the benevolent government -i.e. the public authorities- abandon te patent system ? Should it introduce some change in it ? As H. Varian, pointed it out, there could be various alternative economic models : the most novel and original one being the ‘cooperative’ innovation (with a paradigme far from the dominant one in economic theory) : Linux, an alternative operating system, improves and expands because a community of engineers and IT technicians want to contribute to the Linux project.

This authentic public behaviour might give ideas to the public authorities : why shouldn’t the innovation be a public good ? instead of being ‘produced’ in a competitive market, main innovations could be the fruits of public R&D, and at the reach of everyone. Firms, as well as other agents could expand it -to a minor or marginal scales-.

This proposal, of course, has to be discussed and expanded, but the idea of a public and free innovation monopoly could be a suitable answer to the problem.

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