Technological progress, the mainspring of long-run economic growth, comes from innovations that generate new products, processes and markets. Innovations in turn are the result of deliberate research and development activities that arise in the course of market competition. These Schumpeterian observations constitute the starting point of that branch of endogenous growth theory built on the metaphor of quality improvements, whose origins lie in the partial-equilibrium industrial-organization literature on patent races. Our own entry to that literature was the pre-publication version of chapter 10 of Tirole (1988).
In this chapter we show that the growth model with quality-improving innovations (also referred to as the “Schumpeterian” growth paradigm) is not only versatile but also simple and empirically useful. We illustrate its versatility by showing how it sheds light on such diverse issues as cross-country convergence, the effects of product-market competition on growth, and the interplay between growth and the process of institutional change. We illustrate its simplicity by building our analysis around an elementary discrete-time model. We illustrate its empirical usefulness by summarizing recent papers and studies that test the microeconomic and macroeconomic implications of the framework and that address what might seem like empirically questionable aspects of the earliest prototype models in the literature.