The Innovation-Absorption Dichotomy, Distribution, and Efficiency

Abstract

The fact that some firms innovate while others absorb tech-nologies creates income differences and inefficiencies both within and between countries.We model the industrial market economy, characterized by the coexistence of: 1) large firms with innovation, as in manufacturing and technology, concentrating income and wielding market power, with profits accruing to a small mass of people; and 2) small, approximately competitive firms with little innovation capacity, mainly absorbing technologies. This economy is unequal and inefficient. Free market policies are suboptimal in levels, growth rates, wages, capital accumula-tion and equity. Their levels depend on the steady state of the innovation-absorption dynamics between the two sectors, and can all be improved by taxing profits and subsidizing both innovation and absorption, or by lowering profit mar-gins through a market power tax with zero equilibrium rev-enues. Innovators access a higher return to their investment than the interest rate. Now, consider a second industrial economy whose large scale sector absorbs technologies from the first industrial economy. The first is a developed technological leader and the second an underdeveloped technological follower, that might grow in parallel or diverge. The underdeveloped in-dustrial economy is also inefficient and unequal. Moreover, its small scale sector lags relatively further behind than in the developed economy. Technological policies for equitable, pro-poor growth in industrial economies, developed or underdeveloped, must be two-pronged: supporting both innovation and absorption.