Industrialization, Technological Change and Long-Run Growth

I explore the interaction of market structure and growth in a model of industrialization and endogenous technological change. Along the industrialization path, new manufacturing firms enter the market and expand the variety of goods available to consumers. Competing in the marketplace, firms accumulate knowledge capital in order to reduce costs, offer lower prices, and win market share. As each firm invests in R&D, it contributes to the pool of public knowledge. These intertemporal spillovers allow the economy to grow at a constant rate in steady state. This is reached when entry peters out and the economy settles into a stable industrial structure. The dynamic interdependence of price, investment and entry decisions produce interesting results. The scale effect is zero in this model. An increase in the size of the labor force leads to entry and a larger number of firms. This crowding-in effect induces dispersion of R&D resources across firms, and completely offsets the positive effect of the scale of the economy on the firms' incentives to do R&D. The transitional dynamics provide additional insights. Along the transition path, as entry takes place and the number of firms increases, the growth rate of productivity falls toward its steady state value. The intuition is simple. At the time of the increase in the labor force, the number of firms is pre-determined and does not change. The larger labor supply leads to an increase in aggregate R&D which yields an initially higher growth rate. As entry begins, the dispersion effect due to the crowding of the market kicks in and drives down the rate of growth. Market performance involves two dimensions in this model: the rate of growth of consumption of each good and the variety of consumption goods. Firms do not internalize the trade-off between growth and variety since they do not take into account that establishing in-house R&D programs builds up barriers to entry and reduces product variety. This leads to a Pareto inefficient allocation of resources. The market grows too much and supplies too little variety. This result obtains despite the fact that the presence of intertemporal spillovers, not internalized by the individual firms, should lead to too little growth.