somewhat less ambiguous. Product innovation generally stimulates demand (both domestic and foreign) for the firm‘s outputs and can lead to market expansion. At the same time, like process innovation, product innovation can cause demand diversion from substitute products of other firms (cannibalization or business-stealing effect). Thus, while product innovation will likely enhance the labor demand of the innovating firm, its impact on aggregate employment is less clear, depending on the relative strengths of the market expansion and business-stealing effects. How these countervailing influences of innovation on employment balance in practice is an empirical question whose answer logically depends on the nature of the technology employed and the substitutability of input factors, the own and cross-price elasticities of demand, the degree of competition in the relevant product market, the nature of the business environment, the type of process innovation, the degree of novelty of the new product, and a host of other factors (Peters, 2005).<sup>6</sup>

# **_2.1 Competition and innovation_**

It is fundamental economic theory that idealized competition impels productivity for enterprise survival.<sup>7</sup> In a dynamic setting, market-leading levels of productivity are set by innovation. By offering to successful suppliers the full necessary rewards from investment and marketing initiatives and from relative efficiency, competitive markets provide full incentives for these elements of desirable dynamic behavior. By presenting no impediments to firms‘ following their incentives to vie with each other to meet customers‘ needs and thereby create business, undistorted competitive markets assure that customers will be served by the suppliers best able to innovate and to satisfy demands at the lowest possible cost. It is therefore widely recognized that idealized competition weeds out inefficiency, encourages productivity and technological progress, and generally benefits society by providing a combination of goods and services whose qualities and attributes are adapted to the demands of consumers using up as small a quantity of resources as possible in the supply of these products. Competition also makes enterprise expansion profitable due to the productivity gains that it stimulates.

> 6 Using data on German manufacturing and service-sector firms from the third Community Innovation Surveys (CIS3) for the period 1998-2000, Peters (2005) finds that product innovations have a net positive impact on employment while process innovations are associated with employment reduction for manufacturing but not service firms.  These findings are largely confirmed by Harrison et al (2008) in a study that is also based on CIS3.  Using comparable firm-level data across four European countries—France, Germany, Spain, UK—they find that process innovation has significant displacement effects that are partially counteracted by compensation mechanisms.  The displacement effects of process innovation are most pronounced in manufacturing.  On the other hand, product innovation is associated with employment growth and these results are similar across countries.  Based on a firmlevel comparison across provinces and cities in China, Mairesse et al (2009) find that the compensation effects of product innovation  more than counterbalance the displacement effects of process innovation, the net result being that innovation makes a strong positive contribution to total employment growth.  Alvarez et al (2011) find that in the case of Chile, process innovation is generally not a relevant determinant of employment growth, and that product innovation is positively associated with employment growth.

> 7 Syverson (2011) provides a deep survey of principal recent work on the determinants of enterprise-level productivity.

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