Rationalizing Scherer’s prophecy of an inverted-U relationship between competition and innovation

In this paper we develop a simple Schumpeterian growth model to rationalize the inverted-U relationship between competition and innovation uncovered by Scherer (1967). This model in turn delivers a number of testable prediction. A first testable prediction is that the relationship between competition and innovation follows an inverted- U pattern and the average technological gap within a sector increases with competition. A second prediction is that more intense competition enhances innovation in "frontier" firms but may discourage it in "non-frontier" firms. A third prediction is that there is complementarity between patent protection and product market competition in fostering innovation. More generally, recent attempts at verifying Scherer’s conjectures have given rise to a whole new trend of endogenous growth models aimed at being confronted with micro evidence.