73rd International Atlantic Economic Conference

March 28 - 31, 2012 | Istanbul, Turkey

Rethinking directed technical change with endogenous market structure

Friday, 30 March 2012: 4:30 PM
Lei Ji, PhD , European University Institute, Bologna, Italy
I consider directed technical change with endogenous market structure. Technical change is directed to augment a specific factor by profit-maximizing firms. There are two dimensions of directed technical change: directed firm entry (new firms are directed to enter the industry with higher returns) and directed in-house research and development (R&D is higher in the industry with higher returns.). Directed firm entry responds to the industry market size effect and the price effect as mentioned in the existing literature.  Directed R&D depends on the individual firm's market size, which is endogenously determined. In general equilibrium, the direction of in-house R&D depends on R&D productivity and fixed operating costs. Industry market size plays no role, due to the endogenous market structure. Directed technical change alters the relative demands for factors of production, leading to a change of relative factor returns through two channels. First, directed firm entry changes relative factor returns through a social return to variety (an externality). Second, directed R&D changes relative factor returns through changes in relative factor productivities.  Empirically, the second channel is the main force shaping relative factor productivities hence relative factor returns. Because of its endogenous market structure, the model has both theoretical and empirical implications that are novel, and in some cases are rather surprising.  The model also provides a more complete explanation for wage inequality than before and it shows the importance of the distinction between industry market size and firm market size.  JEL Codes: L10, L16, O31, O40