In our globalized world, competition is a near constant element of working life.  That has not stopped many people on both sides of the Atlantic protesting against the free trade agreement being negotiated between the United States and the European Union.

Whilst there are a number of key concerns raised by the protesters, something that is perhaps not high on their agenda is the impact the increase in competition will have on the innovation of domestic firms.

That was the subject of a recent paper that set out to explore how overseas competition impacted the R&D expenditure of domestic companies.

Spurred on

The paper revealed the intuitive finding that overseas competition, especially from high-income countries, prompted an increase in R&D expenditure by companies in wealthier countries as they attempted to differentiate on quality rather than price.

The authors looked at a range of import/export metrics together with patent records over a 30 year period up until 2005.  Overall, they analyzed around 5,000 companies across the manufacturing sector.

They attempted to gauge the degree of rivalry faced by a company by measuring the amount of imports in the industry as a percentage of the overall consumption levels in that sector.  So if consumers spent $2 billion on imports, but $20 billion overall, the ratio used was 10%.

Drivers of innovation

When the numbers were crunched, it emerged that as competition from imports rose, the R&D expenditure of those in rich, local economies also rose.  What’s more, it tended to be the most successful and innovative companies that responded to competition with greater investment in innovation.

Interestingly, there was a distinct difference depending on whether the competition came from rich or poor countries.  For instance, if a 10% rise in import competition was seen from rich countries, R&D investment would rise by 7%, and the number of patents being filed rise by 5%.  What’s more, these patents tended to be influential, and would receive far more citations by other firms than other patents, thus suggesting that they were influential in their field.

When the competition came from low income countries however, that 10% rise in competition was typically met with a reduction in R&D spending by 13%, with a corresponding drop in patents.  The authors contend that companies regard competition from these companies as being a result of low-wage labor rather than high quality products, and therefore don’t feel the need to innovate as much.

“Taken together, these findings support our arguments that import competition from [high-wage countries] is more like ‘neck-and-neck’ competition, which incentivizes firms, and especially leading firms, to increase innovation effort to stay ahead,” the authors say. “In contrast, import competition from [low-wage countries] is more like laggard competition, which does not prompt the industry leading firms to innovate.”

The findings suggest that overseas rivals can play a substantial part in how we innovate domestically.  Whilst it’s perhaps intuitive to think that the actions of our rivals will influence our own behavior, it’s also worth considering how the actions of overseas rivals may influence other key partners, whether they be supply chain partners or innovation partners.

Suffice to say, patents are not always an accurate indicator of innovation, so I accept the limitations of the study in that sense, but hopefully it will provide some food for thought nonetheless.