Our setting is a dynamic, general-equilibrium model of Schumpeterian growth, and equilibrium unemployment with the following main features. First, growth is endogenously driven by deliberate innovation efforts of entrepreneurial firms. Innovators discover production techniques that lower costs by a fixed percentage. The arrival of innovations is governed by a stochastic Poisson process. An innovator enjoys temporary monopoly profits fueling investments in R&D.
Second, innovators face labor market frictions. They must engage in a stochastic search process to find, organize, and train workers prior to starting production at full capacity. The matching process requires the creation, maintenance, and management of costly job vacancies. Firms optimize the amount of vacancies based on profit maximization. Matching takes place between blocks of vacant positions and workers. As in the case of innovations, the arrival of job-matches is also governed by a stochastic Poisson process. The endogenous arrival of new technologies together with labor market frictions gives rise to search-based unemployment of the Diamond-Mortensen-Pissarides (DMP) type.
Third, firms undertake Rent-Protection Activities (RPAs) to discourage innovation efforts of potential competitors, with a view to prolonging monopoly tenure and delaying the emergence of new technology leaders. We assume that innovation depends directly on R&D investment and inversely on RPAs. In this model, RPAs have two key features. First, RPAs remove the counterfactual scale-effects property from the model resulting in fully-endogenous growth. Second, RPAs are financed by retained earnings and respond to policy changes. Thus, policies that reduce unemployment may hamper growth by increasing the returns to RPAs vis-à-vis R&D. Similarly, policies that increase unemployment may foster growth by raising the relative R&D-RPA returns. As a result, RPAs can be a driving force behind the policy conundrum: jobless growth or stagnant growth with job-creation.
Our general equilibrium results show that adverse shocks to profit flows can lead to low growth and high unemployment. We analyze the effects of several policies used by the governments. Industrial policies in the form of production subsidies to young small firms, production taxes to old large firms, and R&D subsidies to entrepreneurs all stimulate growth but also increase unemployment. In contrast, policies reducing job vacancy costs lead to higher growth and lower unemployment.