Essays on Growth through Creative Destruction Memoria presentada por María Fuensanta Morales Illán para optar al grado de doctor en Economía Dirigida por Jordi Caballé i Vilella Universitat Autònoma de Barcelona Departament d’Economia i d’Història Econòmica International Doctorate in Economic Analysis June 2001 iii Contents 1 Introduction 1 Bibliography 9 2 Financial Intermediation in a Model of Growth through Creative Destruc- tion 11 2.1Introduction.................................... 11 2.2Themodel..................................... 16 2.2.1 Consumers................................ 17 2.2.2 Finalgoodsector............................. 17 2.2.3 Intermediategoods............................ 17 2.2.4 Researchsector.............................. 19 2.2.5 Capitalmarket.............................. 21 2.2.6 Financingofresearch........................... 21 2.2.7 Equilibrium . ........................... 25 2.3SteadyStateAnalysis.............................. 28 2.4Dynamics..................................... 34 2.5Welfareanalysis.................................. 35 2.5.1 Taxoncapital.............................. 38 2.5.2 Taxon…nancialservices......................... 40 2.5.3 Taxonresearchactivity......................... 42 2.6Conclusions.................................... 44 Bibliography 47 2.7Proofsofpropositions.............................. 52 3 Research Policy and Endogenous Growth 61 3.1Introduction.................................... 61 3.2Themodel..................................... 69 3.2.1 Consumers................................ 69 3.2.2 Finalgoodsector............................. 70 3.2.3 Intermediategoods............................ 70 iv 3.2.4 Researchsector.............................. 72 3.2.5 Capitalmarket.............................. 75 3.2.6 Researchpolicy.............................. 76 3.2.7 Equilibrium . ........................... 79 3.3Steadystate.................................... 80 3.3.1 Publicprovision............................. 81 3.3.2 Publicfunding.............................. 86 3.4Welfareanalysis.................................. 90 3.5Conclusions.................................... 95 Bibliography 98 3.6 Distribution of relative productivities across sectors . ....... 101 3.7Proofsofpropositions.............................. 103 3.7.1 Propositionsunderthepublicprovisionassumption......... 103 3.7.2 Propositionsunderthepublicfundingassumption.......... 111 3.8Calibration.................................... 114 3.8.1 Publicprovisionofresearch....................... 115 3.8.2 Publicfundingofresearch........................ 120 3.9Resultswhenprivate…rmsdonotinvestinbasicresearch.......... 122 3.9.1 Publicprovisionofresearch....................... 123 3.9.2 Publicfundingofresearch........................ 127 4 Technological Progress and the Distribution of Productivities across Sec- tors 129 4.1Introduction.................................... 129 4.2Themodel..................................... 133 4.2.1 Consumers................................ 133 4.2.2 Finalgoodsector............................. 133 4.2.3 Intermediategoods............................ 134 4.2.4 Researchsector.............................. 135 4.2.5 Capitalmarket.............................. 142 4.2.6 Publicsector............................... 143 4.2.7 Distributionofrelativeproductivitycoe¢cients............ 143 4.3Equilibrium.................................... 144 4.3.1 Equilibrium under the average assumption. ....... 144 4.3.2 Equilibrium under the aggregate assumption. ....... 146 4.4Steadystateanalysis............................... 147 4.4.1 Steadystateanalysisundertheaverageassumption......... 147 4.4.2 Steadystateanalysisundertheaggregateassumption........ 151 4.5Conclusions.................................... 154 Bibliography 155 4.6Proofs....................................... 157 4.7Dynamics..................................... 171 1 Chapter 1 Introduction The process of economic growth is much more complex than the simple accumu- lation of wealth or capital. Economies today have new products to satisfy new needs and new means of production that make previous technologies obsolete. As Romer (1990) em- phasizes, technological change lies at the heart of economic growth and this implies that economies are always subject to change and innovation. However, technological progress is not only creative, it is also destructive since the design of new goods and production technologies will displace old ones. This process of “creative destruction” is set in motion by the private search for pro…ts and represents one of the sources of economic growth: “...The fundamental impulse that sets and keeps the capitalist engine in mo- tion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.... The opening up of new markets...and the organi- zational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation...that incessantly rev- olutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism...” [Joseph Schumpeter, Capitalism, Socialism and Democracy (1942):] 2 Schumpeter’s view of the economic system was left aside for a long time until it was recovered by the new growth theorists in the last decade. The …rst attempts to construct a growth theory had already identi…ed technological progress as the most important source of growth (Abramovitz 1956; Kendrick 1956; Solow 1957). However, it was modelled as something exogenous, as manna fallen from heaven. A key feature of technological change is that it arises from within the economic system, from the action of private agents in search of higher rents. As Schumpeter writes “...a theoretical construction which neglects...[the process of creative destruction]...neglects all that is most typically capitalist about it; even if correct in logic as well as in fact, it is like Hamlet without the Danish prince.” The purpose of endogenous growth theory is thus, to integrate technological change into the process of economic growth, modelling it as a partially excludable, non rival good arising from “intentional actions taken by people who respond to market incentives.” (Romer 1990). Growth theory has experienced a long evolution since the work of Solow (1957), in which technological progress was the exogenous source of growth and the saving rate was constant. Models like the Ramsey-Cass-Koopmans one1 endogenized the saving behavior but long run growth continued to be out of the picture due to the assumption of decreasing returns. Only in the last decades appeared models with long run endogenous growth. The …rst attempt was performed by the so-called Ak models which overcame the presence of de- creasing returns to capital accumulation with the introduction of externalities arising from government spending (Barro 1990), learning by doing or the stock of knowledge (Romer 1986). These models were able to generate long run growth based on capital accumulation but they ignored the role of technological change induced by private innovation. Conversely, 1Ramsey (1928), Cass (1965) and Koopmans (1965). 3 the work by Romer (1990), Grossman and Helpman (1991) and Aghion and Howitt (1992) opened a new research line for the theory of economic growth. This time, the focus was on the modelling of endogenous technological change. These authors modelized the behavior of research …rms that invest resources in order to get valuable innovations. These innova- tions have value because even though knowledge is non-rival it is partially excludable which, coupled with the introduction of some kind of imperfect competition, allowed researchers to obtain rents from innovation. Two major objections are normally raised against these models. First, that they ignore capital accumulation as a source of growth, and second, that they present scale e¤ects (Jones 1995). Building on the ideas introduced by the previous three seminal papers, other models have introduced modi…cations that avoid the existence of scale e¤ects and that restore capital accumulation in its role as an important source of growth. We are going to focus on this type of models and, in particular, on the framework presented in Howitt and Aghion (1998), Howitt (1999) and Aghion and Howitt (1998). The reason for this choice is threefold: First, the framework is su¢ciently simple to obtain ana- lytical results. Second, it modelizes the R&D and manufacturing sectors of the economy in a way that is complex enough to analyze the most important interactions among economic variables. And third, it is a ‡exible model that allows us to introduce the departures that we want to consider. The basic model is characterized by the presence of a continuum of intermediate goods used as inputs in the production of a consumption good. For each of these intermediate products there exists a research sector competing in a patent race to obtain a better production technology or a new version of the good that increases e¢ciency in production and that will permit the owner of the patent become the monopolist producer 4 of the new version. These advances in productivity are the main source of economic growth. A very important feature of the model is the presence of intersectoral and intertemporal spillovers that a¤ect the gains in productivity …nally