Subsidies in an Economy with Endogenous Cycles Over Neoclassical Investment and Neo-Schumpeterian Innovation Regimes

We explore the roles of subsidies in the Matsuyama model (1999) of growth through cycles alternating perpetually between two phases featuring neoclassical investment and neo-Schumpeterian innovation respectively. Subsidies to R&D investment or to the purchase of newly invented intermediate goods can arbitrarily reduce the threshold level of capital per type of intermediate good, beyond which the economy moves from the investment phase to the innovation phase. More importantly, such subsidies can mitigate and eventually eliminate cycles for ignificant welfare gains that can be equivalent to as much as 10% rises in consumption at all times.