Credit Constraints and Innovation Investment
Develops a dynamic general equilibrium model integrating Schumpeterian growth theory with real business cycle dynamics. Explores how credit market imperfections affect entrepreneurial innovation decisions through a venture capital financing structure. The model features patient households providing seed funding to credit-constrained entrepreneurs who invest in quality-ladder R&D. Examines the tension between the Arrow replacement effect and financing constraints in determining optimal innovation investment, with implications for understanding why R&D patterns deviate from theoretical predictions.
Key Findings
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Credit constraints bind for entrepreneurs: Patient households provide seed funding but entrepreneurs face borrowing limits that restrict optimal R&D investment
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Quality ladder innovation generates endogenous growth: R&D expenditure creates probabilistic quality improvements with cost increasing in technological sophistication
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Venture capital structure affects innovation dynamics: The equity-sharing arrangement between patient households and entrepreneurs creates different incentives compared to standard debt financing
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Arrow replacement effect modified: Credit constraints can override the standard result that incumbents have lower innovation incentives than entrants
Methodology
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Two-agent DSGE model: Patient households (high β) and impatient entrepreneurs (low β) with different time preferences
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Schumpeterian quality ladder: Innovation increases sectoral quality levels by factor λ with probability η(z^E_t)
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Credit market friction: Entrepreneurs can only borrow against expected firm value, creating financing constraints
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Endogenous mark-ups: Monopolistic competition with price mark-ups determined by number of firms per sector
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Calibration to business cycle moments: Model parameters chosen to match stylized facts about R&D and output volatility
Implications
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Financial development matters for growth: Improving access to credit for entrepreneurs can boost aggregate innovation and long-run growth
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Venture capital policy: Policies supporting equity financing may be more effective than debt market interventions for innovation
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Cyclical innovation patterns: Credit constraints can explain why R&D behaves differently from theoretical predictions during business cycles
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Firm size and innovation: The model suggests optimal firm size depends on the balance between financing constraints and market power effects