Traditional economic thinking suggests that competition is essential for innovation to thrive as it drives the creative destruction that sees creative upstarts usurping slovenly incumbents. In such a world, the more competition there is in a market, the better things generally are for all concerned.
Research from Stanford’s Graduate School of Business questions whether this is really the case, not least because it’s an assumption that separates economics and politics from one another. While this simplification can have merit, it often fails to take into account the political influence companies wield when they achieve a certain status.
A growing problem
The authors believe that this issue is only becoming more of a problem as market power is increasingly concentrated in the hands of a single, dominant player. They developed a model to demonstrate how an industry unfolds when firm behavior and regulatory actions are co-dependent on one another.
The results show a clear feedback loop whereby the dominant company co-opts the regulator in a way that helps to entrench its market position even further. In other words, dominant market power helps to deliver even greater market power.
What’s more, by infusing the regulator as somewhat self-interested, the researchers found that it actually wants to protect the incumbent from competition as that company will then have more money for the regulator to share.
Diminishing innovation
What is equally interesting is that the model also suggests that competition may dampen innovation, as the prospect of rivals entering a market may stifle investment. This is because there is a greater incentive for firms to invest money into lobbying in such scenarios than into innovation. Indeed, the more successful one is with lobbying, the less need there is for investment in innovation.
The researchers argue that the typical process is that a startup attempts to disrupt a sector, and then once it achieves a certain scale, it then turns to the government for protection and significantly scales back its innovation. What’s more, the regulator is inclined to grant them that protection as it then has more stable profits (or rents) to extract.
It creates a kind of unholy alliance between the market leader and the regulator. The researchers explain that this isn’t a perfect alliance, however, as the power balance between the company and the regulator vacillates over time, especially if their technological prowess enables the firm to create a protective bulwark of its own and diminish the importance of the regulator.
In such circumstances, it’s likely that the regulator will step back in and try to regain a degree of control again. This is generally a line when the company will cease innovating to ensure it is not crossed. It’s a kind of managed competition that creates a worse outcome than unfettered competition, with both less innovation and lower efficiency.
The researchers believe that the high levels of market concentration in the economy today are likely to be resulting in a loss of productive investment in innovation. While it’s impossible to quantify investments that aren’t made, or innovations that haven’t occurred, they nonetheless suspect that the losses will be considerable.
