On the Timing of Innovation in Stochastic Schumpeterian Growth Models

Abstract

Recent work has revived the Schumpeterian hypothesis that recessions facilitate innovation and growth. But a major source of productivity growth, research and development, is actually procyclical. This paper argues that while it is optimal to concentrate growth-enhancing activities in downturns, dynamic spillovers inherent to the R&D process lead private agents to concentrate too much of their R&D activity in booms, precisely when its social cost is highest. Thus, while previous literature has argued recessions promote growth and intertemporal substitution is a desirable consequence of fluctuations, in the case of R&D recessions discourage growth and intertemporal substitution proves to be a social liability.

Volatility and Growth: Credit Constraints and Productivity-Enhancing Investment

“…at the end of the second period if this additional cost has been met, and nothing otherwise, where q 8 Here we are in effect ruling out any influence of the quality of financial markets the volatility of the aggregate investment rate, which is consistent with the evidence discussed in the introduction. We are also ruling out any influence on the mean investment rate; this is certainly not true in the data, but it is not important for the paper: none of the results is affected if we let w be an increasing function of µ.…”

“…1 Though the idea that there is a close connection between productivity growth and the business cycle goes back at least to Schumpeter, Hicks, and Kaldor in the 1940s-1950s. 2 An opportunity-cost effect of this kind has emphasized by Aghion and Saint-Paul (1998) and more recently by Barlevy (2004).…”

“…King and Rebelo (1993), Stadler (1990), and Jones, Manuelli and Stacchetti (2000) analyze the relation between volatility and growth within the AK class of models, but do not consider the cyclical behavior of the allocation of investment nor the role of financial markets. Hall (1991), Gali and Hammour (1991), Aghion and Saint-Paul (1998), and Barlevy (2004) examine the cross-sectoral allocation of investment, but assume perfect capital markets, thus bypassing the interaction effects identified here. 6 Related are also Caballero and Hammour (1994) and Acemoglu and Zilibotti (1997).…”

Macroeconomic Instability and the Incentive to Innovate

“…1 Some of these, in particular, have focused on the effects of macro-volatility on private investment activity, with sometime conflicting results (Hartman, 1972;Abel, 1983;Dehn, 2000;Pindyck and Solimano, 1993;Bernanke, 1980;Federer, 1993;Serven, 2003, Aghion et al, 2010. A few recent others have looked, in particular, at the link between macro-instability and innovative private investment, in the form of R&D expenditure (Aghion and Saint-Paul, 1998;Goel and Ram, 1999;Saint-Paul, 2003;Rafferty, 2003a;Barlevy, 2005;Aghion et al, 2008;Rafferty and Funk, 2008;Bohva-Padilla et al, 2009). Conflicting results arise in this sub-set of the literature too.…”

“…Those that argue in favor of a pro-cyclical response pattern maintain that a 'cash-flow' effect exists, which financially constrains firms' activities and hinders the undertaking of innovative investment during downturns (Rafferty, 2003a;Rafferty and Funk, 2008;Aghion et al, 2008;Bohva-Padilla et al, 2009, Aghion et al, 2010. Barlevy (2005) adds to this that, although credit constraints certainly account for part of the pro-cyclicality, knowledge spillover effects play their part too. In particular, diffusion and implementation by imitators tends to takes place during recessions when the time to reverse engineer the spllied-over idea before next boom is longer.…”