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The Effect of Credit Rationing on the Shape of the Competition-Innovation Relationship

  • Jan Bena
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Using a dynamic model of a step-by-step innovation race between financially constrained firms, I study how financial constraints affect innovation activity. The novel theoretical results derive from an analysis of the interaction between the incentive effect of competition on innovation and the effect competition has on the degree of credit rationing. I find that the negative effect of financial constraints on firm- and aggregate-level R&D investment is most pronounced at both high and low levels of competition. These predictions are supported by empirical evidence: The competition-innovation relationship has an inverted-U shape in less financially developed systems relative to the benchmark pattern observed in countries with highly developed financial systems. Innovation-enhancing policies implemented through competition reforms ought to be complemented by promoting financial development.

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Paper provided by The Center for Economic Research and Graduate Education - Economics Institute, Prague in its series CERGE-EI Working Papers with number wp377.

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Date of creation: Dec 2008
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Handle: RePEc:cer:papers:wp377
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