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