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Rethinking Directed Technical Change with Endogenous Market ...

Rethinking Directed Technical Change with Endogenous Market ...

Rethinking Directed Technical Change with Endogenous Market

Rethinking Directed Technical Change with Endogenous MarketStructureLei Ji ∗November 7, 2011AbstractI consider directed technical change in an economy where market structure is endogenous. Endogeneityof market structure leads to both theoretical and empirical implications that are substantiallydierent from those in the existing literature and that in some cases are rather surprising. There aretwo dimensions of directed technical change: directed rm entry (new rms enter the industry withhigher returns) and directed in-house research and development (R&D is higher in the industry withhigher returns.). Directed rm entry responds to the industry market size eect and the price eectas in the existing literature. In sharp contrast to the existing literature, directed R&D depends onrm rather than industry market size. Furthermore, the rm's market size is endogenous here, andits response to economic conditions aect several results on the behavior of directed technical change.The endogeneity of rm size has generally been ignored in the previous literature. Directed technicalchange alters the relative demands for factors of production and leads to a change in relativefactor returns. Directed rm entry changes relative factor returns through a social return to variety(an externality), and directed R&D changes relative factor returns through changes in relative factorproductivities. Empirically, the second channel is the main force shaping relative factor productivitiesand hence relative factor returns. The model also includes xed operating cost, which turns out tobe important for the direction of R&D and for the existence of balanced growth path (BGP) for theeconomy. The model provides a complete solution for the economy's transition dynamics as well asits balanced growth path.∗ Department of Economics, European University Institute1

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