Firm Entry and Innovation: An Inverted-U Relationship

This paper studies the impact of firm entry on innovation theoretically and empirically. In the theoretical part, this paper constructs a theoretical model of how firm entry influences innovation. New entrants could have negative “crowding out effect” and positive “spillover effect” on incumbent firms, which result in the inverted-U relationship between firm entry and innovation. Ignoring the combined effects may lead to errors in theoretical interpretation and policy application. In the empirical part, this paper uses various data for as long a period as possible to empirically test the relationship between firm entry and innovation proposed in the theoretical model. At both the firm level and industry level, this paper finds a significant and robust inverted-U relationship between entry rate and firm innovation. This paper puts forward policy suggestions on how to promote the coordinated development of “mass entrepreneurship” and “mass innovation” and improve China’s innovation capacity.