Macro Innovation Dynamics and the Golden Age

The innovative approach presented introduces a modified neoclassical growth model which includes a new bias of technological progress in a quasi-endogenous growth model in which part of labor is used in the research & development sector. The combination of a macroeconomic production function and a new progress function, plus the assumption that the output elasticity of capital is positively influenced by the size of the R&D sector, sheds new light on innovation and growth as well as on income inequality: Thus, there is a new approach for explaining Piketty’s historical findings of a medium-term rise of the capital income share in industrialized countries—both in the earlier and later part of the nineteenth century and in 1990–2010 (this contribution has been published originally in the Journal International Economics and Economic Policy). A rising share of capital income can be explained within this approach by the increase in the output elasticity of capital, which has been developed in a new way, namely in the context of R&D. In the approach presented herein, the golden rule issues are also highlighted, and it is shown that choosing the right size of the R&D sector will bring about maximum sustainable per capita consumption. While the basic new model is presented for the case of a closed economy, one could easily accommodate both trade and foreign direct investment and thereby get a better understanding of complex international investment, trade, and FDI dynamics—including with respect to the envisaged Transatlantic Trade and Investment Partnership between the USA and the EU.

The analysis links R&D, foreign direct investment, output, and CO₂ emissions in a simple growth model. Based on the modified neoclassical growth model, key issues can be raised with respect to sustainable growth and several conclusions can be drawn with respect to economic welfare and optimum consumption per capita, respectively. It may be argued that in several industrialized countries—and China—investment-GDP ratios in certain periods are above the level that is consistent with optimum per capita consumption; the capital intensity exceeds the ratio of capital to workers (in efficiency units) that is consistent with a maximum long-run per capita consumption. CO₂ emission levels could be reduced in an efficient manner on the basis of a broad approach that emphasizes Schumpeterian dynamics: Taxing emissions and giving subsidies for innovations could be useful elements of innovation-enhancing policy. Promoting green innovations—including the sustainability design of products—renewable energy, and realizing adequate genuine savings could be key policy elements for a consistent strategy to achieve sustainable growth. Moreover, green ratings for companies listed on the stock market could be crucial options for combining sustained growth, modernization, and innovation. Part of the analysis is based on the EIIW-vita global sustainability indicator.

Economic growth is, in reality, not a smooth process, and it is not clear why economic growth is rather unstable across OECD countries and the global economy. Economic growth is certainly influenced by many factors, including innovation dynamics and technology, respectively. Technological progress can have domestic sources and is, then, largely related to the innovation system, but in open economies, the subsidiaries of foreign MNCs can also play a role in the host country. Moreover, there could be international technology spillovers, part of which is related to international trade and FDI dynamics. Foreign direct investment has rarely been included in the analysis of economic growth, despite the fact that economic globalization has clearly reinforced the role of multinational companies in world investment. From a macroeconomic perspective, the presence of MNCs’ subsidiaries should not only bring effects on capital accumulation and technology transfer, rather it is important to consider that a distinction has to be made between GDP and GNP. This distinction, which concerns the specification of the savings function as well as other functions, has been much neglected in the literature; it is relevant both in medium-term macro-models and in long-run growth models. In the standard neoclassical growth model with exogenous technological progress, a rise of the progress rate leads to a fall of the level of the growth path and a higher permanent growth rate of output. This suggests that a technology shock should bring about a quasi-growth cycle and such a phenomenon—with a temporary fall of output—is, however, not observed in newly industrialized countries. The empirical patterns of growth and innovation dynamics do not show such a paradoxical temporary fall of income and income per capita, respectively. The paradoxical result of the standard growth model is avoided in a model in which the output elasticity of capital depends on the progress rate; certain parameter restrictions apply which are highlighted in the analysis; furthermore, we get additional insights into the issue of the golden rule and maximization of per capita consumption, respectively. Moreover, it is interesting to consider the role of foreign direct investment for the growth model of an open economy and technological progress, respectively. In this semi-endogenous setup, the focus is mainly on asymmetrical foreign investment, namely inward FDI inflows. Foreign direct investment inflows have a direct impact on the steady state solution, namely both on the level of the growth path and the permanent growth rate—the latter to the extent that we consider a technological progress function in which both the foreign progress rate and the share of the capital stock owned by foreign investors are considered. The relative impact of domestic progress and internationally induced progress is discussed. Finally, the issue of a consistent investment function which takes into account both the short-term and the long-run consistency is considered, and the impact of changes in the progress rate are pointed out—along with broader policy conclusions of the analysis presented. At the bottom line, it is shown that a positive impact of the progress rate on the output elasticity of the capital stock can bring a smooth transition to both a higher level of the growth path and a higher permanent growth rate. The perspectives on the role of FDI inflows in a two-country model with symmetrical flows have to be explored in further analysis. Key policy conclusions concern the question of to what extent government should try to achieve a golden state while adequately taking into account the role of foreign direct investment inflows. Within a broader group of countries, it would also be useful to consider options for cooperation in growth policies—certainly to the extent that there are symmetrical or asymmetric international technology spillover effects.

Traditional open economy macro-models have focused on the mix of fiscal and monetary policy while completely neglecting innovation policy. The new model presented is the first macro-model that explicitly considers product innovations in an open economy model. Product innovations are considered in the consumption function, the investment function, the export function, the import function, the money demand function, and the net capital inflow function. The policy multipliers are derived for fiscal policy, monetary policy, and innovation policy. In an extended version of the model, the role of foreign direct investment is considered, in an approach for a small open economy. Domestic and foreign product innovations are considered, and their impact on policy multipliers is analyzed. Finally, the role of supply-oriented, innovation-enhancing fiscal policy is discussed. Moreover, the empirical evidence for product innovation dynamics is considered.

The macroeconomic production function is a traditional key element of modern macroeconomics, as is the more recent knowledge production function which explains knowledge/patents by certain input factors such as research, foreign direct investment, or international technology spillovers. This study is a major contribution to innovation, trade, FDI, and growth analysis, namely in the form of a combination of an empirically relevant knowledge production function for open economies—with both trade and inward FDI as well as outward foreign direct investment plus research input—with a macro production function. Plugging the open economy knowledge production function into a standard macroeconomic production function yields important new insights for many fields: the estimation of the production potential in an open economy, growth decomposition analysis in the context of economic globalization, and the demand for labor as well as long-run international output interdependency of big countries, and this includes a view at the asymmetric case of a simple two country world in which one country is at full employment while the other is facing underutilized capacities. Finally, there are crucial implications for the analysis of broad regional integration schemes such as TTIP or TPP and a more realistic and comprehensive empirical analysis.