Innovation and Competition: The Role of Finance Constraints in a Duopoly Case
The Review of Austrian Economics, 16:2/3, 183204, 2003.
c 2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
Innovation and Competition: The Role of Finance
Constraints in a Duopoly Case
M. AMENDOLA
University of Rome La Sapienza
J.-L. GAFFARD gaffard@ide.cnrs.fr
University of Nice Sophia Antipolis and Institut Universitaire de France
P. MUSSO
IDEFI-CNRS Sophia Antipolis
Abstract. In this paper we analyse the role of nancial resources in a process of competition interpreted as a
continuous restructuring of productive capacities. Financial constraints appear an essential means of co-ordination.
Co-ordination with the environment where this process of restructuring takes place for the process itself to be
viable and co-ordination between rms for the survival of competition.
Key Words:
competition, co-ordination, nance, innovation
JEL classication:
L11, O31.
1.
Introduction
In this paper we intend to explore the nature of the relation between competition and
innovationwhich is the most effective way to acquire a competitive advantage on the
marketand to stress the particular trade-off that characterizes this relation.
In particular, we will show, with reference to a very simple duopoly market, that incentives
exist which conduce rms to choose strategies that make it possible to take advantage of
potential increasing returns of innovation as determined by the cost reductions associated
with a continuous restructuring of productive capacities.
In this perspective, we shall contrast the view of competition as a process with the
prevailing view of competition as an equilibrium state characterized by an atomistic or
oligopolistic market structure. Viewed as a process, competition has very little to do with
the number of rms which compete on the market. It appears in fact as the co-ordination
mechanism by which potential returns are actually transformed into monetary gains to
the benet of rms, workers and consumers; and, as such, it can be adequately analyzed
irrespective of the number of rms involved in this process.
Co-ordination is required to take care of the structural effects which innovation implies.
However, it would be a mistake to focus directly on the new productive capacity that Present address: CNRS 250 Avenue Albert Einstein F06560 Valbonne. 184
AMENDOLA ET AL.
incorporates the new technology when it is ready to be used, that is when production
costs, dened without any reference to their time dimension, have been effectively reduced.
Innovation is a process. The productive capacity that incorporates the new technology must
be built before it can be used, and its construction needs time. As we shall see, the main
aspect of innovation processes is that there is never a complete synchronisation between
construction and utilization. Consequently, a divorce appears along the way between costs
and proceeds, that actually determines the competitive position of the rms. This actually
depends on their strategic choices as determined by the resource constraints inherited from
the past which affect step by step costs and prices.
In this view, competition cannot be reduced to price competition `a la Bertrand or quantity
competition `a la Cournot given the cost conditions. As a matter of fact, both prices and quan-
tities reect production costs and capacity constraints which change step by step during the
process of restructuring of productive capacity through which innovation is brought about.
Financial constraints appear as an essential means to deal with the co-ordination problems
between competing rms, and of the rms themselves with the environment, which arise
during these restructuring processes.
2.
The Meaning of Competition
Competition is usually looked at as a descriptive term characterizing a particular state of
affairs. In dening this state of affairs the focus is on a market structure, namely a competitive
market, where perfectly competitive implies the existence of an innitely large number
of rms.
In this view, competition appears as a state, interpreted as an equilibrium situation deter-
mined, via a principle of rational behaviour, by essentially exogenous fundamentals that
include given cost conditions and information structures.
1
The distinction between perfect and imperfect competition hides the uniqueness of an
approach which focuses on established fully co-ordinated states of the economy although
corresponding to different cost conditions and information contexts and hence to different
behaviours. In the case of oligopolistic competition, a strategic interaction takes place which
however does not affect the consistency of the production plans of the rms so as to result
in a market disequilibrium
Reference to the market has always been central to the denition of the concept of com-
petition. However, classical economists, who originated this concept, viewed competition
as a price-determining force operating in, but not itself identied as, a market (McNulty
1968:644). The focus was on patterns of business behaviourin particular, behaviours like
price undercutting by sellers, bidding up of prices by buyers, entry of new rms or exits
from the market, and the like. In this view, what is stressed is a process made up by com-
petitive behaviours, rather than the effects of a competitive process, as revealed by a state.
Thus the classical concept of competition, focusing on market activity seen as a process,
was a disequilibrium concept, while perfect competition seen as a market structure is an
equilibrium situation.
But although classical economists saw competition as a process, this was viewed as en-
tirely a phenomenon of exchange in the sense that buying or selling appeared as the critical INNOVATION AND COMPETITION
185
element of economic activity, and the xing of prices its main expression. Competition, in
other words, was not related in a proper way to the phenomenon of production, itself looked
at from the vantage point of trade and exchange. Changes in techniques or in the industrial
organizationthe division of labourwere limited by the extent of the market, so its
analysis in terms of the organization of production within the business rm came to be
circumscribed, even for Adam Smith, by the analysis of the rms external market relation-
ships. Not the essence of the industrial revolutionthe changing mode of productionbut
rather, the mercantilists overriding concern with price, continued to be the central theme
of economic analysis (McNulty ibid.:648).
The only reference to production is represented by the reference to given cost conditions
as determined by the size of the market. This implies a predetermined denition of the
market structure which pushes into the shade the process leading to it. The successive
renements of neo-classical economists led eventually to the abandonment of the reference
to a process and the full identication of the concept of competition with a given market
structure.
3.
Competition as a Process
To go back from the denition of competition as a state to the analysis of competition as
a process implies to look no longer at given data (the fundamentals) which determine
(univocally or less) the (equilibrium) values of the variables of the economy that dene a
competitive state. The fundamentals which determine competitive equilibrium relations,
we have already mentioned, are essentially given information structures and cost conditions.
Hence competition appears as the process by which information is acquired and costs are
determined.
Hayek (1937, 1948) moved a rst step in the direction of the reconsideration of com-
petition as a process by hinting at the problem of changing information associated with
the evolution of technology and preferences. In fact, he dened competition as a learning
process, namely, a process of discovery of the relevant information. Market information
the information concerning price, quantity and quality of goods and servicesdoes not
pre-exist the process of competition, as with the models of the CournotWalras type, but is
a problem the solution of which is brought about exactly by the competition process.
We intend to complement the analysis by also considering the other aspect of the problem:
the changes in cost conditions. We shall do this by focussing on what actually determines cost
conditions: the changing mode of production overlooked also by classical economists. This
im