Market Competition, Innovation and Sustainability

 Is there a desirable degree of market competition to maximise innovation and improve sustainability?

Legally in the UK, monopolies are companies with a 25% or greater market share by value or volume of sales. In controlling such a substantial proportion of the market, monopolies may able to demand higher prices whilst restricting supply, to maximise their profits. Markets dominated by large suppliers (oligopolies) or worse still monopolies lack competition and therefore (potentially) an incentive to innovate to increase their sales. If a small group of potentially colluding companies exert such control and influence, they are likely to act in such a way that maintains the status quo, cementing their positions of power and maintaining their profits. This will likely run counter to the agenda of sustainable development, which demands innovation in new technologies. In a perfect, highly competitive market, with low barriers to entry, new firms could easily be established by entrepreneurs to trial and promote innovate technologies and new ideas that allow for more sustainable lifestyles. Permitting there is perfect information in the market and government subsidies to correct for the under provision of merit goods by such firms, consumers should ‘vote with their pockets’, and polluting, static companies should see declining profits, as consumers buy electric cars, solar panels, homes with better insulation, locally sourced food and suchlike goods and services. To illustrate this, the abstract of an MIT paper based on the thinking of Schumpeter on competitive markets and innovation found that: ‘entrants engage in more “radical” innovations to replace incumbents’.

A particularly striking and extreme example of large, established companies acting to uphold the norms of markets rather than innovate, or pursue ethical and environmentally conscious goals is outlined in the 2017 Guardian article ‘Shell Knew. Here, Damian Carrington and Jelmer Mommers discuss the clearly paradoxical nature of the world’s sixth largest oil and gas company (by 2016 revenue) producing a public information film on the dangers of climate change. The fact that ‘Shell knew’ about the serious implications for our planet of human induced global warming yet continues to generate billions in profit based on fossil fuels, and in 2005 began drilling in the Arctic is morally questionable at best. Although Shell has made some inroads into clean energy (investing $1.3bn in R&D 2013) it is debatable as to whether such action is taken out of concern for the environment, or a desire to diversify the company’s revenue sources, minimise risk and improve the company’s image as global public sentiment shifts in favour of taking action to tackle climate change.

The same MIT paper previously mentioned however, Innovation by Entrants and Incumbents by Daron Acemoglu and Dan Cao found that incumbents- firms that have already established themselves- can also innovate, although this is usually to ‘improve their products’ rather than to create ground-breaking new technologies and ideas. The suggestion that large, established firms can still provide a source of innovation is taken to an extreme by American entrepreneur and venture capitalist, Peter Thiel who argues that monopolistic markets in actual fact prove the most innovative. The argument here is that in highly competitive markets, firms are engaged in a constant battle to survive and are too preoccupied with the everyday tasks of business management to divert resources towards investment and innovation.

It seems the case that Frederic M. Scherer’s theory that there is an innovation maximising level of competition is closest to the truth, striking a balance between firms stagnating and ‘resting on their laurels’ and companies being too concerned with day to day survival to innovate in a meaningful way. Scherer found, through his empirical analysis of Schumpeter’s thinking that: ‘when the four-firm concentration ratio exceeds 50 to 55 percent, additional market power is probably not conducive to more vigorous technological efforts’. Essentially, he is stating that there isn’t a constant linear relationship between market share and inventive activity, but a threshold at which a firm increasing its market share no longer makes it more innovative. Williamson went further, to state that ‘a 5-30 percent market share for the four largest firms is ‘optimal’ from the standpoint of innovative activity’.

Conclusion

In conclusion then, it appears that in terms of market structure, neither a highly competitive market nor an oligopolistic one is universally desirable to improve innovation, and in turn, potentially, sustainability. The extent to which competition and market share influences inventive activity will likely vary from one industry to the next, and it cannot be said that reducing barriers to entry and promoting competition invariably leads to greater levels of innovation in a market. What does this mean for sustainability? It means that there may be an optimum degree of rivalry in industries relating to sustainability (energy, transport, construction, healthcare, education), the achievement of which may lead to more innovations that accelerate a transition to more sustainable economic activity. Although in practice such a level of competition may be difficult to find, it is likely that for most industries, markets comprised solely of monopolies, or small, marginal firms will perform poorly when measured in terms of their inventive capacity. From the viewpoint of policymakers looking to remove the barriers that unfavourable market structures present to sustainable development, the regulation of monopolies through merger policies, antitrust laws and other methods may help to achieve a balance between the extremes discussed, in which firms are both able to and willing to innovate.

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