How Competition Affects Innovation

It’s perhaps natural to believe that competition spurs us to do better, and therefore to be more innovative.  That was indeed the finding of a study published a few years ago, which 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 question has perhaps not been conclusively answered, however, so recent research attempted to delve into the individual layer, and ask how managers respond when faced with import competition.  The study examined firm-level data across Spain from 1993 to 2007, to explore how greater import competition affected the productivity of firms.

The researchers chose Spain because they received greater import competition, not only after integrating with the European Union, but also with the rise of China as a global player.  The data found that when import tariffs were reduced, some firms did indeed improve their productivity, with this particularly pronounced among the least productive firms.

Keeping gains in the family

Interestingly, these productivity gains were highly concentrated in the least productive family firms.  This was especially so when a family member still managed the firm.

The researchers believe much of these changes are driven by a fundamental desire for the firm to survive.  While all managers have an element of care about the long-term health of the firms they manage, this is especially so for managers of family firms, for who the legacy they pass on to future generations is especially important.  Allowing the firm to go bankrupt is often not something they are willing to countenance.

Of course, when competition rises, the risk of bankruptcies rise across the board, but especially for the least productive firms.  The paper argues that the care family managers have for the vitality of their firms is a key factor in their response.

The results are interesting, not least because of the consistently poorer performance of family firms, but also because of the boost to their productivity from greater import competition.  Despite the sometimes parochial image of family firms, they remain an important part of the economy, so such improvements are not to be sniffed at and point at a clear benefit of trade liberalization efforts.