The Relationship between Competition and Innovation – Wolfgang Kerber – June 2023 OECD discussion

Towards a Dynamic Concept of Competition
that includes Innovation
Wolfgang Kerber
University of Marburg
OECD Meeting of the Competition Committee
Relationship between Competition and Innovation
OECD, Paris, 14 June 2023

Wolfgang Kerber: Towards a dynamic concept of competition that includes innovation 2/23
Relationship of competition and innovation?
Approach I:
Approach II: Question about a suitable concept of competition in our innovative
and fast-changing world
- “dynamic competition” concept which integrates innovation as “successful deve-
lopment and application of new knowledge” (OECD 2006) as part of competition
- basic ideas of Schumpeter, Hayek, and evolutionary innovation economics
- “common sense” notion of competition: rivalrous process, in which firms try to
improve their products / services as solutions for the problems of customers
+ improving knowledge is part of competition …
1. Introduction (1)
Competition Innovation

- Main thesis 1:
+ Need for a new, comprehensive dynamic concept of competition that includes
innovation (development of new knowledge)
+ need for going beyond traditional competition economics with the insights of
other approaches about innovation, knowledge, and capabilities
+ (neoclassical microeconomics might work well for price competition but is not
well-suited for innovation processes)
- Main thesis 2:
+ Need for more innovation-specific assessment concepts in competition law
+ example: identification of relevant innovation competitors (“market definition”)
1. Introduction (2)

- Competition: => static concept of competition
+ perfect competition leads to economic static efficiency (defined on a given
set of products / technologies)
+ theoretical industrial economics (based upon game theory)
> analysis of price/quantity (Nash) equilibria (e.g., oligopoly models)
+ market failure: if prices > (marginal) costs => deadweight losses!
- Problem I: Innovation is not integrated in static concept of competition !
+ market failure: incentive problems / public good: => IP / subsidies
- Problem II: Application bias in competition law:
+ main focus on price competition instead on innovation
- Problem III: Assessment concepts deeply influenced by static concepts
+ e.g., market definition => “product markets” / hypothetical monopoly test
2. Towards a broader, dynamic concept of competition that
includes the generation of new knowledge
2.1 Problems of static concepts in competition law & economics (1)

Market structure (competition) and innovation: Current state of knowledge
- Schumpeter vs. Arrow framework
- Empirical studies about Schumpeter hypotheses:
+ firm size => innovation: no innovation-optimal firm size
+ firm concentration => innovation: no innovation-optimal firm concentration
(interesting „inverted U-curve“ discussion)
=> results are different for different industries and technologies
- Theoretical Industrial Economics:
+ large number of models that analyze impact on innovation incentives …
+ Shapiro (2012): contestability, appropriability, synergies
+ many valuable specific insights but, overall, important limitations
- Critique:
+ mostly: market structure => innovation incentives (static equilibrium models)
+ complexity of innovation is reduced to incentives to invest in R&D
2.1 Problems of static concepts in competition law & economics (2)

(see, e.g. Sidak/Teece, 2009; Kerber, 2018)
Towards a dynamic concept of competition:
Need for using insights from more fields of research
Traditional competition
economics
Innovation research
Hayek: Competition as
a discovery procedure
Schumpeterian concepts of
dynamic competition
Evolutionary economics,
complexity economics
Strategic management
(resource-based view of firm,
dynamic capabilities)
Innovation =
development of
new knowledge

need for going deep into innovation research …
Some key insights:
- Innovation processes work differently in different industries / technologies
- firms have different firm-specific capabilities, skill, resources
- innovations often related to each other / collaboration of firms regard. innovation
- appropriability of innovations can be very complex
- innovation: high risks / “true uncertainty” => often no “optimal” decisions definable
- innovation often “trial and error” processes (with feedback loops)
2.2 Taking innovation and innovation research seriously

Two types of Schumpeterian arguments:
- Schumpeter Mark II: (Schumpeter 1942)
+ advantages of large / monopolistic firms regarding innovation
- Schumpeter Mark I: “early” Schumpeter
+ “Theory of economic development” (1934/1911): esp. ch.2
+ entrepreneur, innovation, dynamics, structural change
German theory of dynamic competition:
- Arndt (1952), Heuss (1965), Hoppmann (1977) etc.
- competition as a dynamic, rivalrous process of innovation and imitation
- insights:
+ temporary market power is no problem, only if permanent
+ market structure is endogenous
+ ongoing dynamic process, nearly always in disequilibria
2.3 Schumpeterian concepts of dynamic competition

Hayek’s main contribution to economic theory: => knowledge problem
Hayek (1945): importance of decentralized decisions due to local/decentralized
knowledge (and creative ideas)
Hayek: Competition as a discovery procedure (1948, 1978)
- critique of model of perfect competition (perfect knowledge)
- firms always have knowledge problems about
+ what consumers want
+ what are the best products/services for fulfilling preferences
+ how to produce/provide these best
- competition as a process on markets, in which this knowledge is generated in a
“trial and error” process (learning through feedback from the market test)
=> competition as a process of parallel experimentation of firms, which leads to
“generation and application of new knowledge”
=> without competition: this knowledge would not be generated!
2.4 Hayek‘s concept of „competition as a discovery procedure“

Evolutionary innovation economics:
- broad approach in innovation economics (overview: Nelson et al, 2018)
- example: (simulation) models of Nelson/Winter (1982)
+ combination of
> Schumpeterian competition as innovation-imitation processes
> behavioral theory of the firm (with set of “routines” as knowledge)
> explicit evolutionary (variation-selection) approach on markets
+ evolutionary model that drives technological development (technological
trajectory) and the evolution of the knowledge of the competing firms
+ models a process of parallel experimentation that generates new knowledge
- many other interesting models:
+ evolutionary search models (“fitness landscape models”, Frenken, 2006)
+ replicator dynamics (Metcalfe), agent-based modelling, …
=> these and other models can be integrated in a dynamic competition concept
2.5 Evolutionary innovation economics and complexity economics (1)

Implications of evolutionary concepts for competition:
- heterogeneity of firms and variety (diversity) can be very valuable for the
effectiveness of the knowledge-generating processes of parallel experimentation
in competition on markets
- a larger number of parallel experiments (e.g., parallel R&D projects) can lead to
more / faster development of knowledge (through trial and error)
(Kerber, 2011; for a simulation model Kerber/Saam, 2001)
- importance of diversity emphasized also in competition literature (Rubinfeld/Hoven,
2001; Farrell, 2006: “econodiversity”; Kerber, 2011; Shapiro, 2012; Gilbert, 2019)
- Applicability in competition policy:
+ mergers (horizontal R&D agreements): reduction of parallel experimentation
might slow knowledge generation in competition
=> maintaining a minimum number of innovating firms? (Farrell, 2006; Kerber, 2011)
+ opening markets: to enable many firms with their firm-specific knowledge
and different ideas to offer new problem solutions

Complexity economics (Arthur 2021, Petit / Schrepel 2023)
- different direct dynamic effects (often path-dependent effects), leading to complex
dynamic patterns of industrial or technological evolution
Examples of dynamic / path-dependent effects:
- dominant design / technological paradigms (Dosi) / industry cycles
- first-mover advantages, dynamic economies of scale, critical mass effects
- direct / indirect network effects => “tipping” to quasi-monopolistic platforms
(strengthened through additional feedback loops)
- various types of “lock-in” effects, e.g. also into inefficient technologies, can lead to
market failure through wrong selection of technologies (due to path-dependence)
- … and others …
=> dynamic concept of competition should be capable of integrating those effects
in its analysis

Various strands of the business & management literature can be very helpful for
analyzing innovation in competition processes
+ esp. strategic management literature (Duhaime et al, 2021)
+ looking also what is happening in the firm …
Key question: What can a firm do to achieve a long-term competitive
advantage vis-à-vis its competitors (for high profits)?
Resource-based view of the firm
- goes back to Penrose (1959): firm as a bundle of resources
- bundle of resources: tangible resources, knowledge, capabilities, skills, …
- VRIN strategy: firm should get control over Valuable, Rare, Inimitable and
Non-substitutable resources
- (fits to heterogeneity of firms and evolutionary approach)
2.6 Contributions from business and management research (1)

“Dynamic capabilities” concept (Teece 2007, 2020)
- Teece emphasized dynamic dimension of “bundle of resources” approach
- “dynamic capabilities as the firm’s ability to integrate, build, and reconfigure
internal and external competences to address rapidly changing environments …
[and] achieve new and innovative forms of competitive advantage …”
(Teece/Pisano/Shuen 1997)
- distinction betw. “ordinary” and “dynamic capabilities” (entrepreneurial element)
- example: dynamic capabilities important for orchestrating the evolution of entire
digital ecosystems with many complementing firms (Petit/Teece, 2020)
- Teece also worked on antitrust implications of innovation and dynamic
capabilities approach (Pleatsikas/Teece, 2001; Sidak/Teece, 2009; Petit/Teece, 2021)
- Petit/Teece (2021): developed an own view with regard to a dynamic concept of
competition and how to apply it to competition policy
2.6 Contributions from business and management research (2)

Summarizing key insights for a dynamic concept of competition:
1) Competition as a dynamic process
2) Competition processes should also be seen as processes of parallel experi-
mentation with new problem solutions => generating new knowledge
3) Importance of heterogeneity of firms with firm-specific knowledge, capabilities
and resources (diversity, creative ideas, entrepreneurial capabilities)
4) Innovation incentives very important, but can also be very complex …; and: we
should not focus only on innovation incentives => decisive: “innovation effects”
5) Traditional competition economics can play a valuable role, but we need a much
broader theoretical and methodological basis
6) Dynamic competition concept can still be compatible with normative objective of
consumer welfare, but much broader and flexible concept is needed
7) Competition law is not a problem for a dynamic concept of competition …
=> need for much more research and collaboration of open-minded scholars
from different disciplines and fields of research!
2.7 Conclusions

- in digital economy access to certain sets of data can be necessary for enabling
innovation and competition (data as key driver for innovation)
- EU data policy: making more data available for innovation
+ European strategy for data
+ supporting voluntary data sharing but also increasingly mandatory data
access, data sharing, data portability
- examples:
+ opening public sector data
+ PSD2: opening bank account data with explicit innovation objective (Fintech)
+ Data Governance Act: trustworthy data intermediaries
+ Digital Markets Act: specific obligations for data access, data sharing, data
portability (very narrowly defined, but also for innovation)
+ European Data Spaces, e.g, proposal health data regulation (for research)
+ Data Act proposal of EU Commission (February 2022)
3. Drivers for Innovation: Data, EU data policy and Data Act (1)

EU Data Act: Unlocking IoT data for more innovation and competition (1):
basic idea and instruments
- relevant for all IoT data (and IoT-related ecosystems), in B2C and B2B contexts
- problem: IoT device manufacturers can get through their own technical design
exclusive de facto control over IoT data (e.g., connected cars)
+ leading to access problems for
> users who (co-generate) the data by using their device
> for firms providing services to users but also for data-driven innovation
- key instrument of DA: to grant new rights for the users
+ to access and use the IoT data (only raw data)
+ to share the IoT data with other firms
- key objective: unlocking IoT data for enabling more innovation and competition
on secondary markets, but also innovation in other sectors

EU Data Act: Unlocking IoT data for more innovation and competition (2):
why it will not work …
Huge problems with the Data Act proposal: (Metzger/Schweitzer 2023, Kerber 2023)
- main problem: effectiveness of data sharing mechanism via user rights will be
very low
+ too many hurdles, too narrow scope of data, too high transaction costs, …
+ no solution for interoperability problems, difficult to build aggregated data sets
+ makes getting IoT data via individual users hard, expensive, and unattractive
=> not much unlocking of IoT data, will not help much innovation
- additional provisions with negative effects on innovation and competition:
+ non-compete clause: IoT data from user rights are not allowed to be used
for developing a product that competes with IoT device
+ users not allowed to share data with gatekeepers (Digital Markets Act)
=> Data Act will not support innovation and competition !

EU Data Act: Critical reflections and further perspectives on innovation
What is the main reason for weakness of data sharing mechanism?
- DA proposal emphasizes too much the interests of manufacturers / data holders
with respect to their exclusive control over non-personal IoT data
+ erroneous assumption that manufacturers have an incentive problem for
investing in IoT devices, which would justify quasi-monopolistic monetization
of non-personal data (leading to the need to limit data sharing)
- necessary would be rebalancing in favor of more innovation and competition
- another insight: through technological decisions manufacturers can exclusively
„capture“ the IoT data, i.e. technological innovations can have negative effects on
competition and innovation of other firms
=> Overall: data is a key driver for innovation and competition, but so far many
unsolved problems about the proper design of the governance of data that
favors innovation and competition

Some fundamental questions
- dynamic competition concept: also acknowledges large uncertainty and
unpredictability regarding innovation processes => knowledge problem
- How to deal with innovation in competition law?
- Four opinions:
(1) focussing on price competition, innovation is for IP law
(2) innovation is important but we know so little: let's be very cautious
(3) we can apply our current assessment framework also to innovation
(4) my opinion: we have to develop an own assessment framework for innovation
=> need for more innovation-specific assessment concepts
4. Implications for competition policy:
Need of innovation-specific assessment concepts (1)

Example “market definition” regarding innovation (1)
- “product markets” are not suitable for identifying relevant innovation competitors
- old attempt for solving this: innovation market analysis (Gilbert/Sunshine 1995)
+ innovation-specific approach but never really accepted
- but: very interesting innovative approaches in specific cases
EU Dow/DuPont case (2017)
- competition concerns mostly in crop protection industry (herbicides, insecticides)
+ clearance decision with far-reaching divestitures
+ innovation: development of active ingredients (some similarities to pharma)
- distinction of two types of innovation competition:
+ type 1: overlapping lines of research in specific innovation spaces
+ type 2: R&D efforts at the industry level

Identification of relevant innovation competitors (Dow/DuPont)
Innovation competition II: (industry level)
- analysis of firms in "crop protection industry“: innovation activities + capabilities
(deep analysis of patents and active ingredients)
- only 5 firms have capabilities, assets, scale to perform all stages of innovation;
other active firms do not have the necessary capabilities (5:4 merger)
Innovation competition I: (innovation space level)
- analysis of lines of research / early pipeline products in regard to specific
innovation spaces (herbicides, …, etc.)
- lines of research = set of scientists, patents, assets, equipment which are
dedicated to a given discovery target …
=> decisive: analysis of innovation capabilities, i.e. knowledge / specific resources
=> innovation-specific concept (far away from price-centric product market definit.)

Identification of relevant innovation competitors: critical discussion
- But: no systematic discussion on methodology of innovation-specific approach
- critical questions:
+ what are the relevant capabilities and resources that are necessary for
innovation in certain innovation spaces or at the industry level?
+ how to delineate an “innovation space” or an “industry”?
- what are the methods for deciding these questions?
+ need for much more research (regarding concepts and methods)
+ resource-based theory of firm / “dynamic capabilities” concept, innovation
research might help us to develop such concepts and methods
- we also need innovation-specific approaches for analyzing the effects of the
mergers on innovation ( => going beyond analogies to price competition …)

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