Interaction of Drastic and Incremental Innovations: Economic Development through Schumpterian Waves

Technological progress as a major source of economic development stems from the interaction of two types of innovations, drastic and incremental. While the former sets the fundamental pace of economic progress by redefining production possibilities as Schumpeter strongly emphasized, the latter takes the basic framework as given but pushes the production possibilities frontier outwards marginally in production practice. This paper studies the dynamic interaction and effects of these endogenously-determined innovations. Upstream firms in the model "produce" drastic innovation, which turns out brand new technology and obsolesces the existing technology used by downstream firms that specialize in final goods production. After the downstream firms adopt the new technology, they can improve it further by their incremental innovations. Economic development is shaped as successive Schumpeterian waves, where each wave begins with a great leap forward in technology which is followed by a sequence of adjustments. It is found that a rise in the success probability of future drastic innovations will discourage current efforts at drastic innovation but stimulate incremental innovations. More effort by downstream firms in incremental R&D reduces upstream firms' incentives for drastic R&D. The model ensures at least one dynamic equilibrium. In the case of multiple equilibria, an equilibrium with larger investment in drastic innovation has less expenditure on incremental innovation. The comparative static analysis shows that a reduction in the expansiveness of drastic innovation, and an increase in the total sales of downstream firms and in the significance of drastic innovation will raise (reduce) drastic (incremental) R&D efforts in stationary equilibrium.