Shakeouts, Innovation, and Industrial Strategy and Policy

Abstract

My students of industrial organization play a game in which they manage mock companies producing the same product. Each team periodically chooses levels of investment, capacity utilization, and research spending, and keeps track of its resulting bank balances. An hour after the game begins, typically half of the companies have gone out of business and market share is spread unevenly among the few survivors. The game mirrors a real empirical phenomenon in which, after an initial buildup in number of firms, most industries experience a drop-off or “shakeout” in the number of firms. Sometimes the shakeouts are quite dramatic: in US automobile manufacture, 98.9 per cent of producers exited between 1896, the date an automobile was first commercially produced, and 1967, shortly before Japanese entrants arrived. The top panel of Figure 1 illustrates the rise and fall in the number of US automobile producers, which rose to a peak of (by one measure) 293 firms in 1909 only to fall to 7 survivors by 1955.