Basically Trapped -- A General Equilibrium Approach to the Undersupply of Basic Research in Free Markets

Abstract

In this paper I propose a micro-based innovation driven general equilibrium growth-model allowing for endogenous entry and exit as well as three different types of research. I make the novel distinction between three types of firms, namely basic and applied research where applied research is again differentiated into high and low type research to account for a heterogeneous firm environment. I further propose a new and flexible way to model basic research spillovers in this model class. While previous literature addresses the effect of R&D policies in general, my findings suggest, there is no optimal market solution in which basic research takes a noteworthy share. In order to counteract this undersupply and to take advantage of basic research spillovers, a sizable basic research subsidy is required to sufficiently crowd-in basic research which then allows for a substantial increase in welfare. My findings also suggest the necessity for purely state-financed basic research to approach the social planner solution in a feasible manner.