Economic growth and economic development 568

Introduction to Modern Economic Growth via creative destruction, it will create losers, in particular, the incumbents who are currently enjoying profits and rents Since we expect incumbents to be politically powerful, this implies that many economic systems will create natural powerful opposition to the process of economic growth Political economy of growth is partly about understanding the opposition of certain firms and individuals to technological progress and studying whether this opposition will be successful There is another, perhaps more surprising, implication of the analysis in this subsection This relates to the business stealing effect, which is closely related to the replacement effect The entrant, by replacing the incumbent, is also stealing the business of the incumbent The above discussion suggests that this business stealing effect helps closing the gap between the private and the social values of innovation It is also possible, however, for the business stealing effect to lead to excessive innovation by the entrant To see the possibility of excessive innovation, let us first look at total surplus gain from an innovation starting with the monopolist Suppose to simplify the discussion that the innovation in question is drastic, so that if the entrant undertakes this innovation, it can set the unconstrained monopoly price pM as given by (12.2) above Therefore, the social value of innovation is Sb1I as given by (12.5) Proposition 12.4 It is possible that ˆ I1 , Sb1I < π so that the entrant has excessive incentives to innovate Ô Proof See Exercise 12.8 Intuitively, the social planner values the profits made by the monopolist, since these are part of the “producer surplus” In contrast, the entrant only values the profits that it will make if it undertakes the innovation This is the essence of the business stealing effect and creates the possibility of excessive innovations This result is important because it points out that, in general, it is not clear whether the equilibrium will involve too little or too much innovation Whether it does so or not depends on how strong the business stealing effect is relative to the appropriability effect discussed above 554