Disagreement about Innovations and Endogenous Growth

31 Pages Posted: 5 Dec 2019

See all articles by Christian Heyerdahl-Larsen

Christian Heyerdahl-Larsen

Indiana University - Kelley School of Business - Department of Finance

Philipp K. Illeditsch

University of Pennsylvania - Finance Department

Howard Kung

London Business School; Centre for Economic Policy Research (CEPR)

Date Written: November 19, 2019

Abstract

We study an equilibrium model with disagreement about the likelihood of successful innovations. We show that disagreement stimulates aggregate economic growth and overcomes market failures that would otherwise occur in an equilibrium without disagreement. The higher growth with disagreement comes at the cost of a higher wealth and consumption inequality, as a few entrepreneurs will ex post be successful while most entrepreneurs will fail. Hence, our disagreement model provides a potential explanation for the “entrepreneurial puzzle” in which entrepreneurs choose to innovate despite taking on substantial idiosyncratic risk accompanied by low expected returns. We show that taxes on profits reduce growth because it deters entrepreneurs from innovating, leading to a “Laffer curve” as total tax revenue declines with high tax rates. A flat tax rate does not affect innovation and thus economic growth. A high enough flat tax rate leads to the first best for economic growth, assuming that the government would let all entrepreneurs pursue their way of innovating even though from its point of view many of these ways would seem irrational.

Keywords: Disagreement, Optimism, Entrepreneurship, Externality, Endogenous Growth, Innovations, Laffer Curve

JEL Classification: D51, G10, G11, G18, L26, O30, O40

Suggested Citation

Heyerdahl-Larsen, Christian and Illeditsch, Philipp K. and Kung, Howard, Disagreement about Innovations and Endogenous Growth (November 19, 2019). Available at SSRN: https://ssrn.com/abstract=3490301 or http://dx.doi.org/10.2139/ssrn.3490301

Christian Heyerdahl-Larsen (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

Philipp K. Illeditsch

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-3477 (Phone)

Howard Kung

London Business School ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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