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2008 Market Crash - Stock to Invest In

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2008 Market Crash - Stock to Invest In Powered By Docstoc
					Innovation and Competition:
Theory, Evidence and Policy for
the Great Recession

  Federico Etro
  University of Milan, Bicocca


  Dynamic Competition
  Lecture
  Osaka, November 27 2009
  -Analysis of Business creation & R&D in
      micro- and macro- phenomena
- Many issues under a common perspective
             - Tool of analysis:
    the Endogenous Market Structures
                 Approach

       - Theoretical principles
         - Empirical evidence
         - Policy applications
 • Endogenous market structures (EMSs):
– strategic interactions
– and endogenous entry
– (not free entry with perfect competition, but
endogenous number of firms due to rational entry in
imperfectly competitive markets)
        • wider research on EMSs in:
– industrial organization (Sutton, 1991, 1998, etc),
– macroeconomics, trade, innovation & growth
– industrial and trade policy, macroeconomic policy,
– contract theory and corporate finance
Look at two books..
Advertising!
Traditional approach to market analysis:




Structure     Conduct       Performance
EMS approach to market analysis:


     Conduct        Size




     Structure   Performance
        Example to keep in mind
• Isoelastic utility:                        
                             N 1        1
                        U   C j 
                             j 1   
•     (1, ) degree of substitutability
•   Population of size L
•   can derive direct (and inverse) demand Di
•   assume fixed cost F and marginal cost c
•   Gross profits:  i  ( pi  c )( LDi )
       Example to keep in mind
• Monopolistic competition à la Dixit-Stiglitz
• Optimal mark up:
                                
                                     1
• Number of firms:      1
                         L
                     N
                        F
 Under homogenous goods with zero fixed costs: marginal cost
  pricing and indeterminacy of the market structure
  Cournot competition (homogenous goods)
• Equilibrium mark up:       N
                         
                            N 1
• Endogenous entry:
                            L
               
                          L F
                          L
                N
                          F
             With dynamic entry/exit
          (Etro-Colciago, 2010, Economic Journal):
                                             (1   )(  t 1  Vt 1 )
N t 1  (1   )( N t  N ), e
                                        Vt                              Ft
                                                    1  rt 1
                             t

  • Entry and profits are procyclical & mark ups are
    countercyclical
  • A Competition Effect helps the propagation of shocks
    (beyond the neoclassical mechanism): boom > entry >
    lower markups > higher wages > C and L go up
  • Steady state EMSs depend on:
      –   Market size, L (and productivity A in general equilibrium)
      –   Entry cost, F
      –   Substitutability,
      –   Bankruptcy rate,                       1    AL 
      –   Discounting, r                     N            
                                                  r    F 
                      US (HP) detrended data
  0.2




 0.15




  0.1




 0.05




    0




-0.05




 -0.1




        1950   1955     1960   1965    1970     1975          1980       1985   1990   1995

                               GDP    Mark up   Net Business Formation
                               CONSUMPTION                                                   GDP
           .006                                                     .008

           .005
                                                                    .006
           .004

           .003                                                     .004

  VAR      .002
                                                                    .002
           .001

analysis   .000
                                                                    .000
           -.001

 on US             2   4   6    8     10   12   14   16   18   20           2   4    6   8   10   12   14   16   18   20




  data                              MARK UP
                                                                    .016
                                                                                    NEW INCORPORATIONS

           .000
                                                                    .012


           -.001                                                    .008


                                                                    .004
           -.002

                                                                    .000

           -.003
                                                                    -.004
                   2   4   6    8     10   12   14   16   18   20           2   4    6   8   10   12   14   16   18   20



                                    PROFIT S                                    ADJUSTED SOLOW RESIDUAL
            .03
                                                                    .006
            .02

                                                                    .004
            .01

                                                                    .002
            .00


            -.01                                                    .000


            -.02                                                    -.002
                   2   4   6    8     10   12   14   16   18   20           2   4    6   8   10   12   14   16   18   20
      Implications for the crisis
• Important (supply-side) mechanism of
  propagation?
• Stock market crash > Business destruction
  > concentration > higher mark ups and
  lower wages > lower consumption and
  employment > lower profits …
• .. and trade collapse
 Test of the market size effects
• In the monopolistic competition (Dixit-Stiglitz)
  approach:    log N  log S  log F
• In the EMSs approach (Cournot competition
  with homogenous goods):
                 log N  0.5 log S  log F
• Joint work with Dirk Czarnitzki tests:

     log N jt   0 j  1 j log S jt   jt
Market size vs Number of firms (German NACE 3-digit)
                     2               1
 lnN (within-group means substracted)
     -2         -1        0




                                         -2          -1                 0               1             2
                                              lnS (within-group means substracted)

                                                lnN                       Estimated Regression Line
                                                Dixit-Stiglitz            EMSs (homogenous Cournot)
Market size vs Number of firms (German NACE 4-digit)
                     1
 lnN (within-group means substracted)
          -1     -.5     0      .5




                                        -1              -.5           0             .5           1
                                             lnS (within-group means substracted)

                                                 lnN                      Estimated Regression Line
                                                 Dixit-Stiglitz
    Trade: the Krugman model
• Integration between two equal countries (L=L*)
• Optimal mark up:          
                                1
                           1
• Number of firms:      LL     L
                     N     2
                        F     F
• Gains from trade = gains from variety
     Trade: the Cournot model
              (with homogenous goods)

• Integration between two equal countries (L=L*)
• Optimal mark up:
                          LL
                     
                        LL  F
• Number of firms:
                            LL      L
                     N          2
                             F       F
• Gains from trade = gains from competition
  (lower prices)
• See Ghironi and Melitz (2005, QJE) for a
  dynamic model
• Is this only about competition in the
  market?
• or EMSs have something to say about
  competition for the market?
        EMSs and Innovation
• When competition is for the market:
  – Firms decide how much to invest taking into
    account expected profits and each other‘s
  – Endogenous entry determines:
     • Number of investors
     • Individual investment
     • Aggregate R&D and rate of technological progress
The simplest example of competition for the market
  z = probability of innovation
  V = value of (IPR protected) innovation
  Quadratic costs of investment
Expected profits:

   i  zi  j 1 (1  z j )V  zi  F
               N                    2
                                1
                                2

EMSs:   z  2F
                log(V / 2 F )
        N  1
                       1   
               log         
                    1  2F 
    what about patentholders?
• What is the role of market leaders in investing in
  R&D and promoting technological progress?
• Commonly held view (based on Arrow, 1962):
   – firms invest more in a competitive market where entry
     pressure is stronger
   – incumbents tend to be less innovative than their
     followers
   – incumbents do not invest when entry is free
   – persistence of dominance is signal of market power
     and lack of entry pressure
       Innovation by Leaders
• EMSs results:
  – R&D spending per firm can decrease with entry and
    when entry is endogenous
  – incumbents tend to be more innovative than their
    followers when entry is endogenous (Etro, 2004,
    Economic Journal)
  – persistence of dominance is a signal of competition
    when there is entry pressure
  – In the above example:
                      2F
             z L  1
                      V
              Summing up....
• Two sufficient conditions where incumbent has
  incentive to invest in R&D and invest more than
  others
  – Leadership of incumbent monopolist
  – Endogenous entry for outsiders in the innovation race
Testable hypothesis:
  Investment of incumbent leader is larger than
  investment of the average firm when entry is
  endogenous
             Some evidence
   (from joint work with Czarnitzki and Kraft)
• 2005 survey of the Mannheim Innovation
  Panel
• German Innovation Survey since 1992
• German part of the Community Innovation
  Survey (CIS)
• We focus on manufacturing sector
• 1,857 firm-level observations
                   Variables
• Dependent Variable:
  – R&D intensity = R&D/Sales * 100
• Right-hand side:
  – Incumbent (dummy): a firm that indicates that
    it is larger than its competitors in main product
    market (INC)
  – ENTRY: 4 categories
     • low to high entry pressure in main product market
  – Identify incumbents under entry threat:
     • INC*ENTRY
               Other controls
• Firm size in terms of employment in t-1
  – and its squared value
• Capital Intensity (in t-1)
  = physical assets/employment
• 12 industry dummies
• Additionally: patent stock (since 1978) as control
  – higher protection of previous R&D may lead to higher
    current investment
  – allows us to use some retrospective data to control for
    unobserved heterogeneity
             Econometrics
• We estimate censored regression models,
  as not all firms invest in R&D
  – homoscedastic and heteroscedastic models
    yield same conclusions
• We also test for feedback effects from
  current R&D investment on perceived
  entry threat, as this would bias the
  estimates
Table 2: Heteroskedastic Tobit model on RDINT
  Support for the EMSs results
• Entry threat reduces the R&D investment of the
  average firm,
• but market leaders do invest more in R&D than
  the average firm, the larger the entry threat is.
• Consequently, under these conditions,
  incumbents are more likely to innovate
  eventually.
• This may explain the persistence of the
  leadership
      Implications for growth


 R&D policy to subsidize R&D always
 (Etro, 2008, Journal Macroeconomics)
International coordination of subsidies to
 internalize positive spillovers across
 heterogenous countries (see Alesina,
 Angeloni & Etro, 2005, American
 Economic Review)
     Implications for the crisis
• Need to support R&D Investment through
  – R&D subsidies and
  – IPRs protection
  – Different antitrust attitude toward high-tech
    leaders
         Normative analysis I
Suboptimality of EMSs and Dynamic inefficiency
 Countercyclical fiscal policy and tax rates
  (implications for the crisis: supply side-
  intervention when demand side doesn’t work;
  see Japanese experience)
 Monetary policy aimed at minimizing the impact
  of price frictions on incentives to invest in R&D
  and business creation (see Bilbiie, Ghironi &
  Melitz, 2007, NBERMa)
           Normative analysis II
 Trade policy: export subsidization always optimal
  under endogenous entry (Etro, 2010, International
  Economic Review)                         p
  Optimal export subsidy:
                               *
                                  s 
                                           
  inverse of demand elasticity (opposite of Lerner
  optimal export tax)
   - lower in case of imperfect susbtitutabiliy
   - prohibitive in case of constant or decreasing marginal costs
- Is also the equilibrium subsidy when multiple
  countries adopt it
- Implications: Active protectionism may be good!
 Exchange rate policy to promote exports
 Another case for IPRs protection and R&D subsidies!
   EMSs and Competition Policy
• post-Chicago approach was mainly focused on games with
  an incumbent and an entrant or a fixed number of firms
               (exogenous market structures)
• Ex.: predatory pricing, tying, vertical restraints, mergers…
   • endogenizing entry some results change or need a
                    different interpretation
   – on a general approach: Etro (2006, RAND Journal of Economics;
   2008, Economic Journal)
   – on mergers: Davidson-Mukherjee (2007, IJIO), Erkal-Piccinin
   (2008)
   – on R&D investment and predatory pricing: Kovac-Vinogradov-Zigic
   (2010, JEDC)
   – on technology transfers: Creane-Konishi (2009, IJIO)
   – on tying and vertical restraints
• (timing of) entry becomes crucial in antitrust investigations
           Tying and EMSs:
• The Chicago approach (single monopoly profit
    theorem) associates tying with efficiency
                   reasons
• The post-Chicago approach to tying starts with
            Whinston (1990, AER):
  tying must be anti-competitive when there are a
  monopolist in the primary market and a duopoly in the
  secondary market
  - tying strengthens competition
  > the only purpose of tying is entry deterrence
      EMSs analysis of tying:
• Tying to strengthen competition (reduce prices)
                   is profitable:
  – when there is product differentiation in the
  secondary market
  – when multiple secondary goods can be bought at
  the same time
  – when entry in the secondary market is endogenous
  – when demand for the primary good is close to
  demand for the bundle
 total welfare increases and consumer surplus
   is unchanged (with Dixit-Stiglitz demand)
   A famous case to keep in
       mind: Windows-IE
• The primary market (OSs) is led by Windows
     • the secondary market (browsers) is
               characterized by:
 – product differentiation (IE, Firefox, Opera,
 Chrome,..)
 – multihoming (multiple browsers can be tried and
 used at the same time)
 – endogenous entry (dynamic competitive process
 with entry of new browsers and expansion of
 competitors)
 – demand for Windows is close to the demand for the
 bundle Windows+browser (few want PCs without
 browser)
       A famous case: Windows-IE
                    Source: Net Applications Data


           World market shares for browsers
100%
90%

80%
70%
                                                    Internet Explorer
60%
50%                                                 Other than IE

40%                                                 Firefox-Mozilla

30%
                                                    Safari
20%
                                                    Opera
10%
 0%                                                 Chrome
     20 Q4

     20 Q1

     20 Q2

     20 Q3

     20 Q4
     20 Q1

     20 Q2

     20 Q3

     20 Q4

     20 Q1

     20 Q2
     20 Q3

     20 Q4

     20 Q1

     20 Q2

     20 Q3

     20 Q4

           1
          Q
 04

       05

       05

       05

       05

       06
       06

       06

       06

       07

       07

       07
       07

       08

       08

       08

       08

       09
20
     Conclusions on Antitrust
  • Endogenous number of firms overturn some
       results of the post-Chicago approach
• Entry conditions are crucial to verify an abusive
                       strategy
   • For instance, tying is a normal competitive
  (price-reducing) equilibrium strategy when the
       secondary market is characterized by
                 endogenous entry
            Final remarks
• EMSs are a more realistic representation
  of real markets: imperfectly competitive
• EMSs improve the performance of
  neoclassical models of business cycle and
  trade and growth: explaining better the
  process of business creation and R&D
• EMSs provide new implications for
  macroeconomic policy, trade policy and
  R&D policy: supply-side intervention
• EMSs support many results of the Chicago
  school: entry regulates dominant firms
ありがとう

				
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