Investments in Innovations and Market Structure: A Semi-parametric Approach

The economic literature suggests that there is an inverted-U type of relationship between innovation and product market competition. Existing empirical studies assume a quadratic functional form while estimating the relationship between the two variables. Using data on the Indian manufacturing industry, this article contributes by using a semi-parametric approach to test the ‘Inverted-U’ hypothesis without assuming a priori functional form. The estimation results suggest that the functional form of the relationship is contingent upon the choice of product market competition indicator in the model. When product market competition is defined as overall price competition, the empirical evidence confirms the inverted-U hypothesis. This implies that both escape competition and the Schumpeterian effect are observed as price competition increases. However, when product market competition is defined as domestic competition, only the escape competition effect is observed. JEL Codes: L10, L60, O30, O33, F10