Too big to Innovate? Scale (dis)economies and the competition-innovation relationship in U.S. banking

Abstract

This paper examines whether large U.S. banks have become 'too big to innovate'. We extend the theoretical work of Aghion et al. (2005b) by relaxing their assumption that unit costs are independent from output levels in order to investigate the effect of scale (dis)economies on the competition-innovation nexus. With our model we can derive conditions under which the innovation behavior of firms with scale diseconomies becomes more or less responsive to competitive changes. Our empirical results show that decreases in the level of competition lead to very large drops in innovation. Large banks, already operating beyond the minimum efficient scale, have indeed become 'too big to innovate'.