Optimal Growth Though Product Innovation

In Lentz and Mortensen (2005) we formulate and estimate a market equilibrium model of endogenous growth through product innovation in the spirit of Klette and Kortum (2004). In this paper, we provide a quantitative solution to the planner’s problem in the modeled environment. We find that the optimal growth rate is much larger than the market equilibrium. Furthermore, unlike the market equilibrium in which all firm types invest in R&D, a planner would only allow investment by those that create products of the highest quality. These findings are a consequence of the fact that the value of the spill over effect of an innovation today on the productivity of future products is not fully captured by an innovator in the market equilibrium and the fact that the value of the spill over offsets the value of the expected product that it replaced only if it is of the highest quality. References: Grossman, G. and E. Helpman (1991). Innovation and Growth in the Global Economy. Cambridge, Ma: MIT Press. Lentz, R., and D.T. Mortensen (2005) “An Empirical Model of Productivity Growth Though Product Innovation.†IZA Discussion Paper #1685 and NBER Working Paper #111546.