Public R&D, private R&D and growth: A Schumpeterian approach

This paper introduces public R&D in a tractable Schumpeterian model to study analytically the dynamic effects of changes in public R&D on private R&D, market structure, growth and welfare. While public and private R&D can move in opposite directions in the short run, they move in the same direction in the long run. The tension between the personnel-interaction and knowledge-base effects on one side, and the crowding-out effect on the other, drive these dynamics. The three effects jointly determine firm-level private R&D behavior and thus economic growth in the short run. However, net entry-exit sterilizes the crowding-out effect in the long run, leaving only the first two effects. This difference between short- and long-run behavior rationalizes some of the empirical puzzles documented in the literature. To evaluate quantitatively these analytical insights, we calibrate the model to the USA and feed to it a halving of public R&D that mimics the massive reduction that took place from 1964 to 2021. The economy experiences a long transition characterized by falling productivity of labor in private R&D driven by the falling ratio of public to private knowledge. In the new steady state the growth rate of income per capita falls from 2% to 1.44%. Accounting for the whole transition, welfare falls by about 14%.