Innovation, Knowledge Diffusion, and Selection

Danial Lashkari

No 337, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: This paper constructs a theory of industry growth through innovation and selection-driven creative destruction. Firms’ ideas determine their productivity and stochastically evolve over time. Firms innovate to improve their ideas and endogenously exit if unsuccessful. Entrants adopt the ideas of incumbents. In this model, when better ideas are innovated or adopted, they selectively replace worse ideas. Innovation externalities vary based on firm productivity: ideas generated by more productive firms create 1) longer-lasting positive externalities due to knowledge diffusion and 2) stronger negative externalities due to dynamic displacement of other firms. Therefore, the net external effect of innovation on aggregate productivity is heterogeneous and market equilibrium misallocates investments across firms. The solution to the social planner's problem suggests that optimal innovation policy instruments should depend on firm productivity. Quantitatively, the misallocations are large when the model is calibrated to firm-level data from US manufacturing and retail trade, and imply first-order considerations for the design of innovation policy.

Date: 2018
New Economics Papers: this item is included in nep-cse, nep-dge, nep-ent, nep-ino, nep-knm, nep-sbm and nep-tid
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:337

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