Technological Distance, Growth and Scale Effects

Abstract

We present an endogenous growth model in which the scale effect may be positive or negative, but vanishes asymptotically. The mechanism behind this result provides a microfoundation for models that exploit the interaction of growth and market structure to remove the scale effect. When more firms are active, the economy is more specialised in that firms are less likely to work on related problems. This increase in technological distance reduces the spillovers between firms. A larger economy with more firms accumulates more knowledge. However, the spillovers that benefit a firm do not necessarily increase because of the differentiation of the knowledge stock. One of the puzzles in the theory and empirics of endogenous technological change is the scale effect. Specifically, models in which growth is driven by the accumulation of non-rival knowledge predict that larger economies (measured by a larger labour force) grow faster because (a) they have more resources to devote to knowledge creation and This prediction is difficult to reconcile with empirical evidence. In their study of the cross-sectional evidence Backus et al. (1992) find that GDP growth is not related to the scale of the economy, although TFP growth in manufacturing is positively related to the scale of the manufacturing sector. In his study of the time-series evidence,Jones (1995) finds that the behaviour of TFP growth and R&D investment in the manufacturing sectors of OECD countries is inconsistent with the scale effect. We present an endogenous growth model where the scale effect may be positive or negative but always vanishes asymptotically. What distinguishes our paper from several others, discussed below, is that we provide a microfoundation for a general class of models that exploit the interaction of growth and market structure to remove the scale effect. Moreover, our model is consistent with microeconomic evidence on R&D processes and knowledge spillovers within firms and industries and the role of market structure in shaping these processes. The new feature of our framework is that we model knowledge accumulation and spillovers as two-dimensional: not only does research and development lead to improved understanding of existing problems (intensive margin), but it often implies original formulation of new problems, and new lines of research (extensive margin). Accumulation of knowledge along the intensive margin expands the public knowledge stock and gives rise to spillovers, as emphasised in the standard