Allocative Efficiency and the Returns to Innovation

Koki Okumura

Papers from arXiv.org

Abstract: Innovation changes welfare through the technology it adds and the reallocation it causes between producers with different markups. When producers set markups, an innovator's own output and price adjustments have no private value at the margin, so reallocation reaches its profit only through others' responses. For an innovator small in its markets, none of the change in allocative efficiency, which is of the same order as its cost saving, reaches its profit under quantity or price competition. A process innovator is paid its cost saving, forgoing its own and downstream markups on added output. For U.S. public firms in 2015, these average 14 to 26 percent of that saving, and allocative efficiency rises or falls by more than a tenth of the private return for innovators holding 56 percent of sales. With estimated spillovers, patenting firms' R&D has a social return 6.24 times its private return.

Date: 2026-10, Revised 2026-10
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