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Introduction to Modern Economic Growth
same product line. More importantly, when a particular firm is sufficiently ahead
of its rival, it undertakes less R&D. Therefore, this model, contrary to the baseline
Schumpeterian model and also contrary to all expanding varieties models, implies
that greater competition may lead to higher growth rates. Greater competition
generated by closing the gap between the followers and leaders induces the leaders
to undertake more R&D in order to escape the competition from the followers.
14.4. Taking Stock
This chapter introduced the basic Schumpeterian model of economic growth,
which we referred to as a model of “competitive innovations” to emphasize the
importance of competition among firms both in the innovation process and in the
product market. Competitive innovations lead to a process of creative destruction,
where new products or machines replace older models, and thus new firms replace
incumbent producers.
The baseline model features process innovations leading to quality improvements. The description of economic growth that emerges from this model is, in many
ways, more realistic than the expanding variety models. In particular, technological
progress does not always correspond to new products or machines complementing
existing ones, but involves the creation of higher-quality producers replacing incumbents. Arrow’s replacement effect, discussed in Chapter 12, implies that there is
a strong incentive for new entrants to undertake researchbecause the new, higherquality products will replace the products of incumbents, leading to the process of
creative destruction. Even though the description of economic growth in this model
is richer than the expanding varieties model, the mathematical structure turns out
to be quite similar to the models we studied in the previous chapters. In reduced
form, the model again resembles an AK economy. The main difference is that now
the growth rate of the economy, through the rate of replacement of old products,
affects the value of innovation. Nevertheless, in the baseline version of the model,
the effects of various policy interventions are the same as in the expanding product
variety model of the previous chapter.
An important insight of Schumpeterian models is that growth comes with potential conflict of interest. The process of creative destruction destroys the monopoly
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