Abstract
This paper presents a second-generation Schumpeterian growth model to investigate the existence of possible links between firms’ size, competition stiffness and the effectiveness of R&D policy. In the model, the step size of innovation is randomly drawn from a Pareto distribution, and firms are heterogeneous in terms of market power. The paper finds that the optimal R&D policy is to subsidize R&D and not to tax it, and that more intense competition enlarges the gap between free-market R&D investment and the optimal outcome. However, the paper also finds that the short-run impact on welfare of R&D policy is always negative, and that the recovery time of the welfare loss as a result of the subsidy is negatively related to firms’ market power.
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