Is Growth Mere R&D?

A Model with Two-Stage Product Differentiation

Abstract

The paper presents a growth model where entrepreneurs may invest either in R&D or in physical capital, spreading a two-stage product differentiation. The model finds a double suboptimality. Apart from a static inefficiency which follows from the economy's structure, the model detects a dynamic inefficiency: with laissez-faire, both capital accumulation and innovation are too slow, since entrepreneurs disregard the positive external effect of their investment. Optimum policy measures that make the decentralized market outcome and the social planner's solution coincide are derived.