Master Economics and Public Policy

ECO 553. Economic Growth1

Lecture 9
Schumpeterian Growth
Pierre Cahuc

Winter 2013-2014

1 http://sites.google.com/site/eco553x/
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Introduction

Growth is generated to a large extent by innovations

Previous lecture: innovations = new products with horizontal

dierentiation
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increased specialization generates growth

new products do not replace old products

Actually, growth is also generated by quality improving

innovations (vertical dierentiation) ! new products replace
old products

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Introduction
I

Creative destruction: Joseph Schumpeter: Capitalism,

Socialism and Democracy, 1942
I

innovative entry by entrepreneurs is the force that sustains

long-term economic growth, even as it destroys the value of
established companies that enjoy some degree of monopoly
power
the threat of market entry would keep rms disciplined and
competitive, ensuring they invest their prots in new products
and ideas.
Schumpeter believed that it was this innovative quality that
made capitalism the best economic system

Renewal of ideas of Schumpeter

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globalization and development of service industry: importance

of innovations and scale eects
empirical evidence shows that the process of creative
destruction is very large: high turnover of rms, jobs, workers
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Introduction

Outline
1. Creative destruction: some facts
2. A Schumpeterian model of growth2
3. The ine ciency of market equilibrium

2 Philippe

Aghion and Peter Howitt, 1992, A Model of Growth through

Creative Destruction, Econometrica, vol. 60(2), pp. 323-51. Philippe Aghion
and Peter Howitt, 1998, Endogenous Growth Theory, The MIT Press.
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1. Creative destruction: some facts

Denitions

Large process of reallocations of workers and jobs

Net Employment Change

Hires - Separations
|
{z
}
Workers ows

Net Employment Change

Creation
-{z
Destruction}
|
Job ows

Workers ows are dierent from job ows because dierent

workers can occupy the same job consecutively

Job ows correspond to reallocation of jobs

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across perennial rms

due to entry and exit of rms

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1. Creative destruction: some facts

Job ows

Country
France (84-91)
Germany (83-90)
Netherlands(84-91)
United Kingdom (85-91)
United States (84-91)

Job
creation
12.7
9.0
8.2
8.7
13.0

Job
destruction
11.8
7.5
7.2
6.6
10.4

Net employment
growth
0.9
1.5
1.0
2.1
2.6

Source: OECD

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1. Creative destruction: some facts

Job ows 1997-2005

Country
Brazil
Finland
Germany
Mexico
United Kingdom
United states

Job
reallocation
31.9
23.1
15.5
28.7
30.0
28.3

Excess job
reallocation
26.0
17.3
14.5
26.4
27.3
25.0

Source: Bassanini and Marianna3

3 Andrea

Bassanini and Pascal Marianna Looking inside the perpetual

motion machine: Job and worker ows in OECD countries, OECD social
employment and migration working paper n 95, September 2009.
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1. Creative destruction: some facts

Intra-sector and between-sector job ows
I

If S designates the number of sectors, we look at the net

employment growth in a given sector s (Vns ) and the net
employment growth in the economy as a whole (Vn ).
An initial indicator assesses the extent of job reallocations due
to between-sector movements. It is dened by:
S

RE =

jVns j

s =1

Let Ts be the job reallocation in sector s; the second indicator

corresponds to the sum of excess job reallocations within each
sector:
S

RI =

( Ts

s =1

jVn j

jVns j)

The fraction of job reallocations due to between-sector shifts

is then measured by the ratio RE /(RI + RE ).
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1. Creative destruction: some facts

Intra-sector and between-sector job ows

Country
Germany
United States
France
France
Italy
Sweden

Period
83-90
72-88
84-88
84-91
86-91
85-91

Number of sectors
24
980
15
600
28
28

RE /(R I +R E )
0.03
0.14
0.06
0.17
0.02
0.03

Source: OECD

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1. Creative destruction: some facts

Job ows in the long run in the US 1947-2005: the great moderation

US Quarterly job ows trends Manufacturing and Nonfarm

Business

Source: Davis, Faberman and Haltiwanger (2006)4

4 The

Flow Approach to Labor Markets, Micro-Macro Links, and the Recent

Downturn, Journal of Economic Perspectives, vol 20(3), pp. 326.
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1. Creative destruction: some facts

Job ows: Reallocation due to entry and exit of rms 1997-2005

Total job

Job creation

Job destruction

Job reallocation

Country
reallocation

by entry

by exit

due to entry and exit

Brazil

31.9

6.0

5.0

11.0

Finland

23.1

3.9

3.1

8.4

Germany

15.5

3.2

2.2

5.4

Mexico

28.7

5.5

4.2

9.7

United Kingdom

30.0

5.1

7.2

12.3

United states

28.3

4.6

4.8

9.4

Source: Bassanini and Marianna

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1. Creative destruction: some facts

Job ows and workers ows
40

Hiring rate

30

20

10

0
-20

-15

-10

-5

10

15

20

Employment growth rate

Hires and Establishment Growth in France 2007 to 2010. Quarterly data.

Source: DMMO
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1. Creative destruction: some facts

Job ows and workers ows
40

Separation rate

30

20

10

0
-20

-15

-10

-5

10

15

20

Employment growth rate

Separations and Establishment Growth in France 2007 to 2010. Quarterly

data Source: DMMO
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1. Creative destruction: some facts

Job ows and workers ows
United States

40

Hiring rate

30

20

10

0
-20

-15

-10

-5

10

15

20

Employment growth rate

Hires and Establishment Growth in the US, 2001 to 2010. Quarterly

data. Source: Davis, Faberman and Haltiwanger (2012)5
5 Labor market ows in the cross section and over time, Journal of Monetary
Economic,59 (1), pp. 118

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1. Creative destruction: some facts

Job ows and workers ows
40

Separation rate

30

20

10

0
-20

-15

-10

-5

10

15

20

Employment growth rate

Separations and Establishment Growth in the US, 2001 to 2010.

Quarterly data Source: Davis et al. (2012)
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2. A Schumpeterian model of growth

Aghion and Howitt (1992, 1998)

Growth is generated by innovations that improve the quality

of products and destroy the result of previous innovations by
making them obsolete

Innovations are the result of random discoveries produced by

research activity driven by prots

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2. A Schumpeterian model of growth

Basic framework

L identical individuals, L constant over time

Preferences are represented by the welfare function

U=

c (t )e

dt,

> 0 is the discount rate and c (t ) consumption

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Risk neutrality ! the interest rate r =

Every individual oers one unit of labor per unit of time, at

zero cost

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2. A Schumpeterian model of growth

Basic framework
I

Output, which is consumed, is produced in quantity y (t ) with

one intermediate product with the technology
A( )
x (, t ) , 0 < < 1, A( ) > 0.
(1)

where x (, t ) stands for the quantity of intermediate product

of variety used at time t
Henceforth, for the sake of simplicity, we shall assume that
the quantity of intermediate product is constant over time
and denote
x (, t ) = x ( )
y (t ) =

Innovations improve the quality of intermediate products: an

innovation creates a new variety of intermediate product
whose productivity is larger by a multiplicative factor > 1
than the previous intermediate product
A( + 1) = A( )
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2. A Schumpeterian model of growth

Basic framework
I

Individuals can work

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either in the intermediate product sector

or in the research sector

One unit of labor in the intermediate product sector produces

one unit of intermediate product
Let us denote by n( ) the quantity of labor in the research
sector when the intermediate produt is used:
L = x ( ) + n( )

Innovations are produced at rate n( ), (there are n( )dt

innovations over the small interval of time [t, t +dt ]) where
> 0 is a parameter that measures the productivity of
research
Firms which innovate can monopolize the production of the
new intermediate product
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2. A Schumpeterian model of growth

Basic framework

Innovations create 3 externalities

1. The monopoly rent obtained by the innovator is generally
smaller than the surplus induced by the innovation
2. Every innovation increases A and then the productivity of
future research (knowledge is a non rival good)
3. Destruction of previous intermediate products

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2. A Schumpeterian model of growth

The value of an innovation
I

Let us denote by ( ) the ow of prot of the rm that

produces the intermediate product

The value of innovation made at time t, denoted by V (, t )

is dened by
V (, t ) =

1
[ (, t )dt + [1
1 + r dt

n(t )dt ]V (, t + dt )]

or
rV (, t ) = ( )

n( )V (, t ) + V (, t )

with V (, t ) = 0 because ( ) and n( ) do not depend on

time, so that, we can write V (, t ) = V ( ) which satises:
V ( ) =

( )
r + n( )

(2)

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2. A Schumpeterian model of growth

Wages

Labor market is perfectly competitive: wages are equal to

marginal productivity

Marginal productivity in research

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one unit of labor produces an innovation with probability per

unit of time
value of an innovation when the intermediate product is used
is equal to V ( + 1)
therefore, the wage in research when the intermediate product
is in use is
w ( ) = V ( + 1)
(3)

Perfect competition ! unique wage: wage in research sector

is equal to the wage in intermediate product sector.

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2. A Schumpeterian model of growth

Intermediate product sector
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Intermediate products are produced by monopolies

The monopoly which produces the intermediate product get
a prot ow
( ) = max p ( )x

w ( )x,

(4)

where p ( ) denotes the price of the intermediate product

The relation between the price and the quantity of the
intermediate product is deduced from the maximization of
prots of the representative rm which produces the nal good
Final output sector is perfectly competitive ! marginal
productivity of intermediate product in this sector,
A( )x ( )

is equal equal to the price

p ( ) = A( )x ( )

(5)
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2. A Schumpeterian model of growth

Intermediate product sector

Substituting the expression for p ( ) dened equation (5) into

equation (4), we see that the rm which produces the
intermediate product
max A( )x

w ( )x

The solution is
x ( ) =

( )

( ) = A( ) (1

1/(1 )

, ( )
)

( )

w ( )/A( )

(6)

/( 1 )

(7)

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2. A Schumpeterian model of growth

Equilibrium
I

The equilibrium value of prots (7), the value of an

innovation (2) and the value of the wage (3), allow us to write
the artitrage equation that equalizes the wage in research and
in the intermediate product output:
(1 )
( ) =
r + n( + 1)

( + 1)

/( 1 )

(A)

The equilibrium values of n and are dened by

I
I

(A)
labor market equilibrium, L = x ( ) + n( ), which can be
written, using (6):
L=

( )

1 / (1 )

+ n( )

(L)

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2. A Schumpeterian model of growth

Stationary growth
I

n ), satises equations (A)

Stationary solution, denoted by (,
and (L):
1/(1 )

(1 )
=
(AS)

(r + n )
1/(1 )
+ n
(LS)

(AS) denes a decreasing relation between the wage and the

quantity of labor used in research
L=

Interpretation: higher future wages decrease future prots and

then the returns to research

(LS) denes an increasing relation between the wage and the

quantity of labor used in research
I

Interpretation: wage increases reduce employment in the

1 / (1 )
intermediate product sector (the term
) and then
increase employment in research
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2. A Schumpeterian model of growth

Stationary growth
I

) is dened by the intercept of

The stationary equilibrium (n,

an increasing curve and a decreasing curve in the (n, ) plane.
Thus it is unique when it exists (which is assumed henceforth)
The stationary value of labor in research is
n =

(1

) L (r /)
(1 ) +

0.

(8)

The quantity of output produced with the intermediate

product is
A( )
y ( ) =
(L n ) ,

This yields, together with A( + 1) = A( ),

y ( + 1) = y ( ),
where stands for the sequence of innovations = 1, 2...
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2. A Schumpeterian model of growth

Stationary growth
I

Let us compute the average growth rate of output

I
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there are ndt

innovations over every small interval of time
dt ! 0
every innovation increases the logarithm of output by ln()

Change in production at between dates t and t +dt can be

written
ln [y (t + dt )] = ln [y (t )] + ndt
ln()

Using the approximation6

limdt !0 ln[y (t +dt )/y (t )] = limdt !0 [y (t +dt )/y (t )]
get the average stationary growth rate
y (t + dt )
dt !0
dt

g = lim
6 We

y (t ) 1
y (t )
=
= n ln()
y (t )
y (t )

know that limx !1 ln x = limx !1 x

1, we

(9)

1
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2. A Schumpeterian model of growth

Stationary growth

Equations (8) and (9) allow us to dene the average

stationary growth rate as function of the exogenous variables:
g = ln()
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(1
(1

) L r
) +

(10)

The logarithm of output increases discontinuously, after every

innovation, by an amount ln()
The average spell between 2 innovations is equal to 1/n.

In this model, more intensive research, induced by more labor

in research, entails more frequent innovations and a higher
growth rate

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2. A Schumpeterian model of growth

Static comparative properties
I

The average growth rate

g = ln()

(1
(1

) L r
) +

increases with
I

L the size of population

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the productivity of research

the size of the increase in production induced by innovation

decreases with
I
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r the interest rate

which measures the level of competition in the intermediate
product sector7

7 The

absolute value of the elasticity of demand for intermediate products,

dened equation (5), equal to 1/(1 ), increases with so that the
monopoly power decreases with .
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3. The ine ciency of market equilibrium

I

It is possible to compute the optimal growth rate, which

maximizes
Z
q (t )e rt dt
U=
0

The optimal solution yields the stationary optimal growth

rate8
g = n ln()
where n satises
1=

8 Details

(
r

1) 1 (L n )
n ( 1)

(11)

are given in Aghion and Howitt (1998), Chapter 2 pp. 61-63.

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3. The ine ciency of market equilibrium

I

The comparison of n (dened equation (8)), the stationary

quantity of labor used in research at market equilibrium,
which can be written as the solution to
1 =

(L n )
.
r + n

(12)

and n , the socially optimal stationary quantity of labor used

in research, which solves
1=

(
r

1) 1 (L n )
n ( 1)

(13)

shows 3 dierences between the socially optimal rate of

growth and the market equilibrium rate of growth

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3. The ine ciency of market equilibrium

1. Dierence between the social discount rate, r n ( 1),
at the denominator of (13) and the private discount rate at
the denominator of (12)
I Social discount rate < private discount rate
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Intertemporal externality (present research increases

productivity of future research)
Research too low at market equilibrium

) shows up in (12) but not in (13)

The monopolies obtain only a share (1 ) of the surplus

2. (1

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3. (

induced by innovations, as shown by the expression of prots

(7)
Appropriability eect
Research too low at market equilibrium

1) in (13) instead of in (12)

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Innovators no not take into account the cost associated with

destruction of old products
Destruction eect
Too much research at market equilibrium
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3. The ine ciency of market equilibrium

I

The Schumpeterian model shows that the level of research

can be either too high or too low at market equilbrium, with
respect to the socially e cient level

The 2 rst eects dominate when the size of innovations, , is

large. In this case n < n .

When the monopoly power is strong ( small), and the size of

innovations su ciently small, the destruction eect dominates.
In this case, there is too much growth at market equilibrium

There are other costs associated with the destruction eect:

unemployment9

9 Pierre

Cahuc and Andr Zylberberg, 2009, The Natural Survival of Work,

Job creation and job destruction in a growing economy, MIT Press
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