Patents and Growth in OLG Economy with Physical Capital

We study the implications of patents in an overlapping-generations model with horizontal innovation of differentiated physical capital. We show that within this demographic structure of finitely lived agents, weakening patent protection generates two contradicting effects on innovation and growth. Weakening patent protection lowers the (average) price of patented machines, thereby increasing machine utilization, output, aggregate saving, and investment. However, a higher demand for machines shifts investment away from the R&D activity aimed at inventing new machine varieties, toward the formation of physical capital. The growth maximizing level of patent protection is incomplete and we show that shortening patent length is more effective than loosening patent breadth in spurring growth. Shorter patent length has an additional positive effect on growth by decreasing investment in old patents. Finally, we show that the welfare implications of shortening patent breadth depend on consumer time preference and the degree of machine specialization.