| Abstract: |
This paper analyzes equilibrium, dynamics, and optimal decisions on the factor
bias of innovation in a model of induced innovation. In a model with full
employment, we show that (a) if the elasticity of substitution is always less
than or greater than unity, there is a unique steady state equilibrium; (b) if
the elasticity of substitution is less than unity, the steady state is stable,
but convergence is oscillatory; (c) if the elasticity of substitution is
greater than unity, the steady state is a saddle point; and (d) if the
elasticity of substitution is less than unity for both high and low effective
capital labor ratios but greater than unity for intermediate values, then
there can be multiple steady states. In a model where efficiency wages lead to
equilibrium unemployment, we show that if the elasticity of substitution is
less than unity, there will be a bias towards excessive labor augmenting
innovation, resulting in too high unemployment, with convergence to the unique
steady state being oscillatory, rather than monotonic. Similarly, if the
elasticity of substitution between skilled and unskilled labor is less than
unity, and there is efficiency wage unemployment for unskilled labor only,
there is will be excessively skill-biased innovation. This paper provides an
alternative resolution to the Harrod-Domar conundrum of the disparity between
the natural and warranted rate of growth to that of Solow, with strong policy
implications, for instance, concerning the effects of income distribution and
monetary policy both in the short run and the long. |