The paper investigates the relationship between product market competition and innovation, finding strong evidence of an inverted-U relationship using panel data. The authors develop a model where competition discourages laggard firms from innovating but encourages neck-and-neck firms to innovate. Together with the effect of competition on the equilibrium industry structure, these generate an inverted-U relationship. The model also predicts that the average technological distance between leaders and followers increases with competition, and that the inverted-U is steeper when industries are more neck-and-neck. The paper provides empirical evidence supporting these predictions using UK panel data. The inverted-U relationship is confirmed by the data, and the results are robust to various controls and experiments. The paper concludes that competition may increase innovation and growth by reducing preinnovation rents more than postinnovation rents, and that the balance between the escape-competition effect and the Schumpeterian effect generates the inverted-U relationship. The model also provides additional testable predictions on the relationship between competition and the composition of industries, which are supported by the data. The paper is structured into sections discussing the impact of competition on innovation, explaining the inverted-U relationship, and concluding with the main findings.The paper investigates the relationship between product market competition and innovation, finding strong evidence of an inverted-U relationship using panel data. The authors develop a model where competition discourages laggard firms from innovating but encourages neck-and-neck firms to innovate. Together with the effect of competition on the equilibrium industry structure, these generate an inverted-U relationship. The model also predicts that the average technological distance between leaders and followers increases with competition, and that the inverted-U is steeper when industries are more neck-and-neck. The paper provides empirical evidence supporting these predictions using UK panel data. The inverted-U relationship is confirmed by the data, and the results are robust to various controls and experiments. The paper concludes that competition may increase innovation and growth by reducing preinnovation rents more than postinnovation rents, and that the balance between the escape-competition effect and the Schumpeterian effect generates the inverted-U relationship. The model also provides additional testable predictions on the relationship between competition and the composition of industries, which are supported by the data. The paper is structured into sections discussing the impact of competition on innovation, explaining the inverted-U relationship, and concluding with the main findings.