Induced Innovation, Endogenous Growth, and Income Distribution: a Model along Classical Lines

This paper presents a classical micro-founded growth model with endogenous direction and size of technical change. In a standard induced innovation model firms freely adopt productivity improvements from an innovation possibilities frontier describing the trade-off between increasing capital or labor productivity. The shape of the innovation possibility frontier uniquely determines the steady state distribution of income. The model proposed allows firms to choose not only the direction but also the size of innovation by making innovation a costly activity requiring R&D investment. Comparative dynamics analysis shows that income distribution is are sensitive to saving parameters and fiscal policy. In particular, an increase in the discount factor or in subsidy to R&D raises the labor share.