On the Direction of Innovation (with Francesco Squintani)
Abstract
:
How are resources allocated across different R&D areas? We show tha
t under a plausible set of assumptions, the competitive market allocates ex
cessive innovative efforts into high returns areas, meaning those with high
er private (and social) payoffs. The underlying source of market failure is
the absence of property rights on problems to be solved, which are the sou
rce of R&D value. The competitive bias towards high return areas comes thre
e distortions. The first two are familiar in the context of a single innova
tion line: the cannibalization of returns of competing innovators and dupli
cation costs. The third one is new to the innovation literature: excessive
entry into high return areas results as the market does not take into accou
nt the future value of an unsolved problem while a social planner does. All
ocation of resources to problem solving leads to a stationary distribution
over open problems. The distribution of the socially optimal solution stoch
astically dominates that of the competitive equilibrium. A severe form of r
ent dissipation occurs in the latter, where the total value of R&D activity
equals the value of allocating all resources to the least valuable problem
solved.