Too little or too much R&D?

According to the first generation models of endogenous growth based on expanding product variety, the market economy unambiguously generates too little R&D. Later, by disentangling returns to specialization from the market power parameter, it was shown that with sufficiently low returns to specialization too much R&D can occur. The present paper takes a step further, disentangling the market power parameter from the capital share in final output. We show that this helps finding too much R&D as well. In addition, by differentiating between net and gross returns to specialization it is demonstrated what drives the differing inefficiency results in this literature. The decisive factor behind excessive R&D is the implicit presence of negative externalities of increased specialization. Empirically, an advantage of the more general framework is better agreement with the observed level of markups and the observed falling tendency of the patent/R&D ratio.