Optimal R&D subsidies in a model with physical capital, human capital and varieties

a r t i c l e i n f o In this paper, we analyze the social planner solution of an endogenous growth model with physical capital, human capital and R&D. The model incorporates three sources of inefficiency: monopolistic competition in the intermediate-goods sector, duplication externalities and spillovers in R&D. A complete stability analysis for the optimal growth problem of this model is provided. We characterize the optimal policy that can decentralize the optimal solution and find that the path of the optimal R&D subsidy can be non-monotonic. There is a broad consensus that physical capital accumulation, knowledge formation, and R&D-based technological progress are the three main engines of growth. For the most part, they have been considered as alternative rather than complementary explanations in the theoretical literature. As a notable exception, Arnold (2000a) and Funke and Strulik (2000) (AFS henceforth) proposed an integrated endoge-nous growth model with physical capital, human capital and R&D, in which the economy passes through different stages of development. In the fully-industrialized phase three sectors are acting: the competitive final goods sector, the schooling sector where knowledge (human capital) is accumulated, and the intermediate-goods monopolistic sector which produces an increasing variety of goods due to R&D. However, monopoly power is not the only plausible source of inefficiency in R&D-based growth models (see, also supports the existence of R&D spillovers in innovation — a " standing on shoulders " or a " fishing-out " effect. Several authors have also pointed out that the R&D activity may be subject to an external effect associated to the duplication and overlap of research effort — a " stepping on toes " effect (e. 1995). Intuitively, the larger the number of people searching for ideas is, the more likely it is that duplication of research would occur. Evidence of duplicative research has also been found, e.g., by Kortum (1993) and Lambson and Phillips (2007). Both external effects — spillovers in R&D and duplication externalities — are neglected in the AFS model, which assumes that innovation depends exclusively and linearly on human capital devoted to R&D. Additionally, Gómez (2011b) has recently examined the ability of the simplest AFS model to describe the development process and concluded that it can hardly be reconciled with data. First, Gómez (2011b) notes that previously reported simulations with the AFS model made by Funke and Strulik (2000), Gómez (2005) and Iacopetta (2010) feature three main …