Not Enough R&D? Or Maybe Too Much? Intensity of Knowledge Spillovers and Optimal R&D Policy in Schumpeterian Growth Theory

Abstract

This paper presents an endogenous growth model à la Aghion & Howitt (1992) in which we explicitly formalize knowledge spillovers in the innovation process. We revisit the issue of the Pareto non-optimality of the Schumpeterian equilibrium by revealing the part played by the intensity of knowledge spillovers. Basically, we highlight that the market incompleteness characterizing this type of decentralized economy (knowledge is not priced) is all the more likely to lead to an under-optimal (resp. over-optimal) R&D effort as the intensity of knowledge spillovers is high (resp. low). The reason behind this is that the effects of the distortion of R&D incentives resulting from market incompleteness are amplified all the more as this intensity is strong. Complementarily, we derive the optimal tool dedicated to correct the market failure caused by market incompleteness, and we demonstrate that it clearly depends on the intensity of knowledge spillovers: the higher (resp. lower) the intensity of knowledge spillovers is, the more likely this policy tool should consist in a subsidy (resp. tax). Moreover, if this optimal tool happens to be a subsidy, then this subsidy will be all the larger as the intensity is high.