Economic Report President

The United States has a decades-long history of enforcing itsantitrust laws to ensure that mergers, acquisitions, and other structuralchanges in firms and markets do not unduly empower the resultingenterprises to raise prices or restrict output. The use of antitrustpolicy as a framework for preserving and encouraging innovation, however,is a more recent development, on which there is less consensus.The relationship between an industry’s market structure and theamount of innovative activity in that industry may differ from the relationshipbetween market concentration and short-term price competition,the conventional focus of antitrust. Whereas concentration nearlyalways weakens price competition, its effects on innovation are lessclear-cut. Antitrust authorities investigating today’s mergers thus confronta difficult task: they must not only assess the likely effects of consolidationon prices and output in the relevant product market, butalso account for a merger’s potential impact on innovation and thebenefits it promises to consumers in the long run.DO BIGGER FIRMS HELP OR HURT INNOVATION?Several recent mergers are notable for their sheer size. In the lastfew years the financial services, telecommunications, and petroleumindustries have all seen mergers or proposed mergers valued in thetens of billions of dollars. Antitrust policy in the United States doesnot, however, generally treat firm size per se as important for determiningthe strength of competition. Market share, which does not necessarilycorrelate with size, is understood to be the more relevantdeterminant of whether prices and quantities are set competitively.There has been greater debate, however, about the relevance of firmsize for innovation. Indeed, one could make perhaps as strong a theoreticalcase that bigness is good for innovation as that it is bad or indifferent.Some commentators, following the economist Joseph Schumpeter,have praised large enterprises for their superior ability toattract the financial and human capital, bear the risk, and recoup theinvestment required for sustained research and development (R&D)activities. Small firms, on the other hand, have been touted as morecreative and more nimble in adapting to changes and opportunitiesthan their larger, more bureaucratic counterparts.Empirical studies have consistently found that big enterprises aremore likely than small ones to undertake at least some R&D. In addition,among those firms that do undertake R&D, bigger firms tend tomake larger R&D investments. Beyond a threshold level of size, however,it is less evident that larger firms’ R&D investments are proportionatelygreater than those made by smaller firms. Most recentresearch supports the consensus view that, in general, R&D rises onlyproportionately with firm size.Data matching R&D investment with the number of patents generatedhave shown that smaller firms produce more innovations per174