Should Governments Subsidize Resource-Using Variety-Expanding Innovation or Resource-Substituting Innovation?

This study introduces endogenous resource-substituting innovation into a variety-expanding endogenous growth model with polluting non-renewable resources. The resulting task-based framework highlights the trade-off between resource-using variety-expanding innovation and resource-substituting innovation. We examine how subsidies for these two types of innovation affect economic growth and welfare, and how environmental policies that slow resource extraction and mitigate pollution shape these effects. Subsidies for new-variety R&D promote growth through faster variety expansion but reduce it through greater reliance on resource extraction, reflected in a lower share of firms adopting resource-substituting production methods and higher resource intensity in aggregate production. Subsidies for resource-substituting innovation have the opposite effects. Calibrating the model, we find that raising subsidies for new-variety R&D is more likely to improve welfare in resource-rich economies, whereas raising subsidies for resource-substituting innovation is more likely to improve welfare in resource-poor economies. We also find that more stringent environmental policies that conserve resources and mitigate pollution strengthen the welfare gains from subsidies for resource-substituting innovation, while weakening those from new-variety R&D subsidies.