Disagreement about Innovations and Endogenous Growth

Abstract

We study an equilibrium model with disagreement about the likelihood of successful innovations. We show that disagreement stimulates aggregate economic growth and overcomes market failures that would otherwise occur in an equilibrium without disagreement. The higher growth with disagreement comes at the cost of a higher wealth and consumption inequality, as a few entrepreneurs will ex post be successful while most entrepreneurs will fail. Hence, our disagreement model provides a potential explanation for the “entrepreneurial puzzle” in which entrepreneurs choose to innovate despite taking on substantial idiosyncratic risk accompanied by low expected returns. We show that taxes on profits reduce growth because it deters entrepreneurs from innovating, leading to a “Laffer curve” as total tax revenue declines with high tax rates. A flat tax rate does not affect innovation and thus economic growth. A high enough flat tax rate leads to the first best for economic growth, assuming that the government would let all entrepreneurs pursue their way of innovating even though from its point of view many of these ways would seem irrational.