This dissertation studies the effect of competition on firms' decisions for heterogeneous innovation, and its implication for the recent decline in business dynamism in the U.S. in the context of increasing competitive pressure by foreign firms due to globalization. In Chapter 1, I theoretically investigate the effect of competition on firm innovation by developing a discrete-time endogenous growth model where multi-product firms do two types of innovation subject to friction in technology spillovers. Firms improve their existing products through internal innovation while getting into product markets outside of firms' scope through external innovation. Novel friction I consider is that it takes time to learn others' technology during external innovation, which I denote as an imperfect technology spillover. In contrast to existing models, this friction allows incumbent firms to defend themselves from competitors by building technological barriers through internal innovation. I calibrate the model and run counterfactual exercises of increasing competition, where competition is from either outside of the economy, such as foreign exporters, or domestic firm entry. I find that regardless of the source of competition, domestic incumbent firms i) increase their internal innovation for products they have a technological advantage while decreasing it for products with no technological advantage, and ii) decrease their external innovation. This shift of innovation composition lowers firms' investment in overall innovation in the U.S., where firms are creative in the sense that they do a lot of external innovation. However, increasing competition increases firms' investment in overall innovation in an economy where firms do less external innovation. In an economy with high external innovation costs, firms put very little resource for external innovation even before increasing competition, which implies that there is little room for adjustment. Thus, although external innovation is decreased after an increase in competition, this small reduction is more than offset by increased internal innovation for defensive reasons. These findings highlight the importance of examining the composition of innovation as opposed to overall innovation, and sheds light on the reason for the differential effect of the same competition shock, such as Chinese import competition, on firms' overall innovation across different countries identified by recent studies.

In Chapter 2, I empirically test the model predictions derived in Chapter 1, and by building on these findings, I argue that the decline in high-growth firm activity and startup rates in the U.S. is a result of multi-product firms' optimal innovation decisions in response to increasing competitive pressure by foreign firms due to globalization. The three predictions I derive using a simplified three-period version of my model are i) increasing competition makes innovative firms increase their investment in internal innovation for defensive reasons, ii) if innovation intensity is high in the economy, firms do less external innovation, and iii) increasing expected profit makes firms invest more in internal innovation. By using firm-level data from the U.S. Census Bureau integrated with firm-level patent data from the USPTO, I find regression results consistent with the model's predictions. Then, I extend the baseline closed economy model developed in Chapter 1 and build a two-country endogenous growth model to show that increasing competitive pressure by foreign firms contributes to the recent decline in high-growth firm activities and startup rates in the U.S. by inducing innovation-intensive and thus fast-growing firms to invest more in internal innovation for defensive reasons. And because innovative incumbents in each product market are now good at protecting their markets with heightened technological barriers, all types of firms find it difficult to enter others' markets through external innovation. Thus, the startup rate falls, and all firms reduce their investment in external innovation. This shift in innovation cuts the employment growth of innovation-intensive firms, as external innovation makes firms grow faster than internal innovation by requiring firms to hire a new set of workers to produce new products.