Patent Puzzle, Inflation, and Internal Financial Constraint

Although Schumpeterian growth models typically predict that stronger patent protection enhances innovation-driven economic growth, the empirical evidence does not support this idea. We explore the unclear relationship at work by shedding light on the financing of R&D investment. Empirically, R&D-intensive firms preferentially rely on their internal cash flows rather than external funds. We develop a simple monetary Schumpeterian growth model in which R&D firms face an endogenous financing choice that is consistent with this evidence. In our model, the scale of R&D investment may be financially constrained by internal cash because external financing is costly. Our model shows that the relationship between patent protection and growth can be either N-shaped, inverted-U shaped, or positive depending on the inflation rate. Specifically, we find that the growth effect of the pro-patent policy is likely to be negative under a high inflation rate, while the growth effect is always positive under the Friedman rule.