Abstract
Endogenous growth models may exhibit either under or over-investment in R&D. The possibility of over-investment is generally attributed to a business stealing effect that arises as the latest innovator destroys and/or appropriates previous incumbent's rents. We argue that this conventional wisdom is misleading. In standard models, business stealing by itself cannot result in excessive R&D. We explain the other effects that must be at work here, thus contributing towards a better understanding of when and why the market may be biased towards excessive R&D.
Highlights
It is a well known fact that R&D-driven endogenous growth models may exhibit either under- or over-investment in R&D
Over-investment is caused by a business-stealing e¤ect that arises as the latest innovator destroys and/or appropriates previous incumbent’s rents
We argue that in standard models, business stealing by itself cannot result in excessive R&D
Summary
The innovation reduces the unit production cost from c0 to c1. If the innovation is non-drastic, as in this panel, the latest innovator sets a limit price p1 = c0. One obvious candidate is the R&D congestion e¤ect ( known in the literature as the crowding e¤ect, the stepping-on-toes e¤ect, or the winner-takes-all e¤ect) This is represented by the decrease in the probability of a ...rm’s competitors’success resulting from an increase in that ...rm’s R&D investment, or the corresponding increase in their cost needed to achieve the innovation with a given probability. With constant returns to R&D, the only cause of over-investment is a monopoly distortion e¤ect noted by Aghion and Howitt (1992), but hardly mentioned in subsequent studies This is an equilibrium property of so-called “scarce-factors” models, where there is a factor of production (labour) that is in ...xed supply and can be used exclusively for the production of innovative goods or for the purposes of research. Rst section endeavours to prove these claims for quality ladder models, whereas section 2 examines models with expanding product variety
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