An Analysis of the Importance of Both Destruction and Creation to Economic Growth

A growth model is studied in which the destruction (or exit) decision is decoupled from the creative (or research) decision. In contrast with the existing literature, the approach adopted here emphasizes that these important decisions are made by different agents, but they ultimately influence each other. As such, the destruction decision is just as important as that of creation, and in the model if destruction ceases, then so will growth. Any distortion introduced into one of these decisions will then inevitably affect the other as well. It is then possible to characterize endogenous features of the equilibrium such as the number of workers and firms, the determinants of income mobility, income inequality (Gini Coefficient), the growth rate, the lifespan of a firm, and the effect of various taxes or distortions. A planning problem is also studied, and it is shown that a multitude of factors may yield an optimum exit decision that is different from the equilibrium decision rule. This may mean that the equilibrium can give rise either too high or low a level of innovation, but also the destruction or exit rate may also be too high or low. It is then shown that a non-linear tax/subsidy scheme, which alters the research and exit decisions, may improve welfare, relative to the equilibrium level. The model also yields welfare benefits/costs that are considerably different from what one might normally expect.