Technology and

Growth in
Developing
Countries :
Technology Creation,
Diffusion and Transfer

Source:
David Weil: Ch 7, 8
Barro and Sala-i-Martin: Ch 8
Aghion and Howitt : Ch 3
Introduction

Technology played an important role in growth convergence and divergence among the countries .

Pritchett (1997) estimates that the proportional gap in living standards between the richest and poorest
countries grew more than fivefold from 1870 to 1990.

Barro and Sala-i-Martin (1992) , Mankiw, Romer, and Weil (1992), and Evans (1996) observed that since 1960s,
most countries seems to be converging to parallel growth paths.

However, many poor countries are continuing to diverge.

The proportional gap in per capita income between richest and poorest convergence groups grew by a
factor of 2.6 between 1960 and 1995, Mayer-Foulkes’s (2002)
The proportional gap between richest and poorest groups grew by a factor of 1.75 between 1950 and
1998 (Maddison’s (2001)
Introduction
Solow–Swan model analysed that the tendency for convergence across economies originates from the diminishing
returns to capital. The higher rate of return on capital in poor economies push for a faster rate of per capita growth.

Ramsey modified this idea by the behaviour of the saving rate. The convergence rate was faster or slower depending on
whether poor economies tended to save a higher or lower fraction of their incomes.

The international mobility of capital among open economies tended to speed up the process of convergence.

Economies could sustain positive per capita growth in the steady state if the returns to a broad concept of capital, which
includes human capital, were constant. If the returns to broad capital diminish for awhile, but are roughly constant
asymptotically, economies exhibit convergence behaviour but also feature endogenous growth in the long run. Study
shows that imbalances between physical and human capital affected the transitional dynamics. Economies that began
with a high ratio of human to physical capital would grow especially fast.

Long-term growth arises if R&D investments—the source of technological progress in these models—exhibited constant
returns.

In a multi-economy setting, the key issue is how rapidly the discoveries made in leading economies diffuse to follower
economies. The diffusion of technology provides another reason to predict a pattern of convergence across economies.
Productivity
vs Factor
Accumulation

For each group, the average level of factors of production relative

to the United States has been calculated. In the richest group of
countries (which includes the United States), the average level of
factor accumulation is equal to 94% of the U.S. level; in the
poorest group of countries, factor accumulation equals only 19%
of the U.S. level.
Growth of Hong Kong and Singapore (1966–1990).
It was found that although productivity growth played a large role in the
growth of Hong Kong’s income, Singapore’s income growth was
almost entirely driven by factor accumulation.
In Hong Kong, productivity grew at a pace of 2.3% per year; in Singapore,
the comparable figure was 0.2% per year.
Source: Weil
India has 216.2 researchers per one
million inhabitants, against 1,200 in
China, 4,300 in the US, and 7,100 in
South Korea,
Technology Transfer
One result of technology’s nonphysical nature is that although conventional factors of production are rival in their use,
technology is non-rival. If a piece of physical capital such as a hammer is being used by one person, it cannot be used by
another. Similarly, a piece of human capital such as an engineer’s technical training can be used in only one productive
task at a time. Exactly the opposite is true of technology. One person’s use of a piece of technology in no way prevents
others from using it just as effectively.

The non-rival nature of technology implies that transfer of technology among firms or countries would be a great boon. If
a country is poor because it lacks capital, then it can raise its income only by undertaking the costly investment of
building new capital. By contrast, if a country is poor because it lacks technologies, then technologies can be transferred
from elsewhere without making the country from which they were taken any worse off.

The non-rivalry of ideas is often bound up with a low level of excludability. Excludability is the degree to which an
owner of something (such as a good or an input into production) can prevent others from using it without permission.
Physical capital has a high degree of excludability. As a result, the owner of a piece of physical capital is able to earn a
return by charging other people for its use. By contrast, ideas are often non excludable—their very nature makes it hard to
prevent someone else from using them. Often, because of non-excludability, the person who has created a new technology
will not reap most of the benefits from its creation. This fact diminishes the incentives for creating technology.
Determinants of R&D Spending

Most R&D spending is undertaken privately by firms

Profit Considerations:
•The amount the firm will want to spend on R&D will depend on how much of an advantage a new invention will confer.
•The firm will be influenced by the size of the market in which it can sell its product.
•The firm will take into account how long the advantage conferred by a new invention will last.
•The uncertainty surrounding the research process will influence a firm’s R&D spending.

Creative Destruction
The profits a firm earns as a result of creating a new technology sometimes come at the expense of other firms. Economist
Joseph Schumpeter described the process by which new inventions create profits for firms, which serve as the incentive
to engage in research in the first place, Schumpeter’s phrase nicely captures the double-edged nature of the process.
Along with the success of new technologies, we tend to ignore the dislocations suffered by firms and workers that the
new technologies displace.

Example: Powerloom vs Handloom

This also creates significant amount of monopoly rent and have often tries to stifle new generations of technologies. For
example, in 2000, a U.S. district court found Microsoft guilty of having abused its monopoly in operating systems to stymie
innovations in the computer industry
Patent System
A patent is a grant made by a government that confers on the creator of an invention the sole right to make, use, and sell
that invention for a set period of time, generally 20 years.

Patentable items include new products and processes, chemical compounds, ornamental designs, and even new breeds of
plants. (Copyright, a related form of intellectual property protection, applies to writing, music, images, and software,
among other things).

To receive a patent, an inventor must produce something that is both novel (i.e., not something that was already known)
and nonobvious. Further, one cannot patent laws of nature, physical phenomena, or abstract ideas. Inventors generally
must file for a patent separately in every country where they want to protect their invention

Although in theory the rules for what can be patented are straightforward, in practice it can be complicated to apply
them. For a start, the issue of whether an invention is novel and nonobvious turns out to be in the eye of the beholder.

In the 1860s, the U.S. Supreme Court ruled that attaching a rubber eraser to the back of a pencil was not a patentable
idea because it was not novel. However, in 2003, the J. M. Smucker Company was successfully able to patent a crustless
sandwich made from two slices of baked bread.

Novartis Case in India : The Swiss pharmaceutical company’s effort to patent an updated version of its cancer drug was
rejected. The Supreme Court has said that product was known prior to 1995, and a new patent cannot be granted
because it is just a little modification on the old one.
Challenge in the Patent System
Earlier, patents could be registered without any official check on their feasibility. In modern patent
systems, scientifically trained examiners must approve each patent, but their resources can be
overwhelmed by the flood of applications.

Another difficulty in applying the rules of a patent system is in deciding which inventor deserves the
patent. There are two types of standards used. In a “first to file” system, the party (inventor or
corporation) that brings its application to the patent office first receives the patent. The drawback of
the first to invent system is that it can involve complex investigation and litigation to establish who
actually came up with an idea first.

Further, a patent in the first to invent system is never fully secure because it is always possible that a
previous inventor will show up and take it away. This makes it difficult for inventors to sell their patents
and makes firms less confident in investing in patented technologies. A first-to-file system creates
certainty but introduces other problems. Established firms with large legal departments have a
significant advantage in filing patents relative to small start-ups.

Once a firm has developed a particular technology, the firm will act as a monopolist, maximizing its revenue by charging a
high price and, in doing so, limiting the benefits of the technology.

In some cases, the balance between encouraging new R&D, on the one hand, and holding back progress of other firms doing
similar work, on the other, can go awry.
Technology Creation and Growth
LY be the number of workers who are involved in producing output.
Labour
LA be the number of workers who are involved in creating new technologies

Production In per-worker terms

Productivity Growth The rate of technological progress is a function of the number of workers who are
devoting their time to R&D.
μ is the “price” of a new invention, measured in units of labour. In other
words, μ tells us how much labour is required to achieve a given rate of
productivity growth
Growth Rate
The level of output per worker, y, is just proportional to the level of
technology, A
 The bigger the labor force, L, the larger
the growth rate of technology

if suddenly increases. the growth rates of both output, y, and

productivity, A will rise. But there is a second effect of increasing
Moving workers into the R&D sector will mean involving fewer
workers in producing output.

Panel (a) shows, when rises, the growth rate of technology rises as well.
The increasing steepness in the line representing A illustrates this rise.
In panel (b), the line representing y also becomes steeper, indicating that the growth
rate of output per worker has increased.
But at the moment increases, there is a jump downward in y, representing the loss
of output from workers shifting away from production and into R&D. Panel (b) makes
clear that eventually output will regain and then pass the level it would have reached
had there been no change in .

Thus, a country that devotes more of its resources to R&D will suffer a reduction in
output in the short run but be better off in the long run.
A Two Country Model: Issue of Technology Transfer
Technology transfer stresses the interplay of two different means by which a country can acquire a new technology. The
first is innovation—the invention of a technology. The second is imitation, or copying a technology from elsewhere.

Labour Labour forces of the two countries are the same size: L1 = L2 = L.

Productivity Growth
Per Capita
Production

μc the cost of acquiring a new

Technology Gap technology via imitation (the c is for
“copying”).

Key assumption is that the cost of copying goes down as the technology gap between the follower and the leading
country widens. There are several ways to justify this assumption. One justification is that not all technologies are
equally easy to imitate, and that the farther behind the leader a follower is, the more easy-to-imitate technologies
there are available to copy. Alternatively, we could say that what affects the cost of imitation is the time since a new
technology was invented—thus the farther the follower lags behind the leader, the older (and thus easier to copy) are
the technologies that the follower wants to imitate.
A Two Country Model: Cost of Copying Technology

Three assumptions on “cost of copying” function.

•It is downward sloping—that the cost of copying falls as the technology gap between the two countries increases
(i.e., as the ratio of technology in Country 1 to technology in Country 2 increases).

•As the ratio of A1/A2 goes to infinity, the cost of copying falls to 0. In other words, if the gap in technology were
infinitely large, then imitation would be costless.

•As the ratio of A1/A2 approaches 1, the cost of copying approaches the cost of invention. This means that if the
follower country is very near to the technology leader, it gets little benefit from copying technology rather than
inventing its own. (The cost-of-copying function is not defined if A1/A2 is less than 1 because in this case, there
would be nothing for Country 2 to copy.)
A Two Country Model: Cost of Copying Technology Steady State Situation

The growth rate of A in each country as a function of A1/A2, the ratio of technology
in the leader country to technology in the follower country.

When A1/A2 ratio is 1, cost of copying is equivalent to do innovation, but country 2’s tech growth will be less as share of
labour in R&D is higher in country 1. When A1/A2 is infinite, cost of copying is zero and technology growth rate of Country 2
will be more than Country 1.

At some ratio of A1/A2 between 1 and infinity, the two countries will have the same growth rates of A, and the ratio of the levels
of technology in the two countries will remain constant. This will be the steady state.
 Summary

In the steady state, the two countries must grow at the same rate. If Country 2 were growing faster than Country 1, then
Country 2 would become the technology leader, an impossibility given that Country 2 spends less on R&D than Country 1.

If Country 1 were growing faster than Country 2, the technological gap between them would grow infinitely large, and the
cost of copying for Country 2 would be 0—in which case Country 2 would grow faster than Country 1.

Given that the two countries grow at the same rate and that Country 2 devotes less effort to R&D than Country 1, Country 2
must have a lower cost of technology acquisition than Country 1, and we can determine the specific cost by comparing the
levels of R&D effort in the two countries.

For example, if Country 2 devotes half as much effort to R&D as Country 1 (i.e. , ), then the cost of
technology copying in Country 2 must be half as large as the cost of invention in Country 1 (i.e., ).
Is the technology-leading country necessarily better off than the follower?

Although the technology leader is more productive, it also devotes a higher fraction of its labour force to R&D and thus
has fewer workers producing output. ( Positive and negative impact on Output)

Whether it is possible for the follower to have a higher level of income than the leader will depend on the costs of
imitation relative to innovation.

If imitation is inexpensive, then a follower country will have a level of productivity near that of the leader while
devoting a much smaller share of its labour force to R&D. (lower imitation cost and smaller share of R&D workforce)

If imitation is expensive, then the follower country either will have to devote almost as much of its labour force to
R&D as does the leader, in which case its level of technology will be close to the leader’s, or else will have a level of
technology that is far behind that of the leader (Need to increase R& Dworkforce)
Effect of an Increase in R&D in the Follower Country on the Steady State

At steady state

Country 2 raises its value of but that the new value is still
below the value in Country 1. The curve representing shifts
upward.

This shift means that for any given value of A1/A2, Country 2 is
growing faster than it would have grown before the increase

The new steady state occurs at a lower value of A1/A2, that is, a
smaller gap in technology between the two countries.

But at the steady state, both the countries’ technology will eventually
grow at the same pace.
Effect of an Increase in share of R&D labour force on Productivity and Output

The growth rate of technology in Country 2 temporarily rises after

Over time, however, as A2 moves closer to A1, technological growth in

Country 2 returns to its old level. The reason is that the steady-state growth
rate of technology in Country 2 is determined by the growth rate of
technology in Country 1, the technology leader.

The immediate effect of an increase in is the reduction of output in

Country 2, because a smaller fraction of the labour force is involved in
producing output.

But the increase in R&D effort leads to faster growth in A2 and thus in y2.

Growth in Country 2 is temporarily high while the level of technology in

Country 2 is moving toward the level in Country 1, but once the new steady-
state ratio of A1/A2 has been reached, growth in Country 2 returns to its
rate before the change in
Discussion
The follower country adopts this model of growth through technology creation shares one of the properties of the models
of factor accumulation which leads to a transitory change in the growth rate of output. Eventually, the growth rate of
output will return to its level preceding the change in policy, although the level of output will differ from what it would
have been without the policy change.

The result that a change in R&D spending will lead to only a transitory change in the growth rate of output does not hold
true for the leader country in this two country model. Because the leader country does not have the option to imitate
technology from abroad, it is effectively in the same situation described in the one country model: A change in R&D will
lead to a permanent change in its growth rate of output.

So the question is how do we determine who is the leader?

The scenario of one country leading the world in every technology, with every other country playing catch-up, might have
been nearly correct at some points in history—for example, for the United Kingdom in the early 19 th century and for the
United States soon after World War II. But in the world today, technological superiority is much more diffuse, with many
countries crowding the “technological frontier” and different countries leading in different industries.

The general lesson of the model is that increased R&D spending within a given country will have two effects.
First, it will change that country’s relative position in the world technological hierarchy and thus bring a period of
transitory growth in both technology and income within the country.
Second, increased R&D spending in a given country will lead to faster growth in technology for the world as a whole.
 Should we be Optimistic or Pessimistic ?
The model assumes that technology moves freely, at least in the form of imitation from rich to the poor countries and
that increases the growth rate of the poor countries.

Although technologies move fairly freely among the most developed countries, many technological advances in the
rich countries appear to have little impact on the poorest countries

It is possible that technologies developed in the richest countries will not be “appropriate” to poorer countries. If
technologies created in rich countries are specific to the mix of factors found there—that is, if the technologies
work only with high levels of human and physical capital—then such technologies will not be useful in poor countries.

Neutral Tech Change
Capital based tech change
This analysis leaves open the question of why R&D
labs in developed countries do not create
technologies that developing countries can use. One
reason is that developing countries typically enforce
property rights to new technologies
laxly. The inventor of a new technology that benefits
producers in poor countries will find it almost
impossible to get those producers to pay to use his or
her invention and thus to earn a return on his or her
investment. Such slack enforcement weakens the
incentive to create technologies that are useful in
poor countries.
Tacit Knowledge
Experience with the transfer of technologies from rich to poor countries has shown that there is much more to such transfer
than simply carrying the blueprints for new production processes across national borders. In addition to the codified
knowledge represented by a set of blueprints, there also exists tacit knowledge in the minds of engineers—thousands of
small details about the workings of a technology, learned over years of experience and transferred from person to person,
not in written form but through informal training. Often the users of a technology are unaware themselves of the extent of
this tacit knowledge, so the transfer of blueprints alone, without tacit knowledge, can lead to expensive failures.
Embodied Technological Progress
Not all examples of technological progress are as simple as software. New technology is often built into capital goods. This
linking of technology to specific pieces of capital is called embodied technological progress (by contrast, software is an
example of disembodied technological progress). If a technological change is embodied in capital, the technology is not
upgraded until the capital good is replaced.
The technology can also be embodied with human capital ( specific education, training etc)

Leapfrogging
The embodiment of technology in capital goods also gives rise to the possibility of technological leapfrogging, the process
by which technologically backward countries or firms jump ahead of the leaders. One of the best examples of leapfrogging
comes from software. Software is constantly being improved, but the typical
computer user does not find it worthwhile to upgrade every time a new version of software becomes available. Instead, the
user will stick with his or her current version of a program until it is antiquated enough that replacing it is worthwhile, at
which point he or she will adopt the newest available version. Thus, there is a constant process of leapfrogging, by which
the users with the most antiquated software jump ahead to install the most modern program
Putty-Clay Framework

Technologies classified according to Ex ante the technology involves capital which is

factor substitutability ex ante and ex post
“putty” in the sense of being in a malleable state which
can be transformed into a range of various machinery
requiring capital-labour ratios of different magnitude.
But once the machinery is constructed, it enters a
“hardened” state and becomes ”clay”. Then factor
substitution is no longer possible; the capital-labour
ratio at full capacity utilization is fixed.
Phelps (1963),

Johansen (1972), said that a putty-clay technology involves a “long-run

production function” which is neoclassical and a “short-run production
function” which is Leontief.
The clay property ex-post of many technologies is important for short-run analysis. It implies that there may
be non-decreasing marginal productivity of labour up to a certain point. It also implies that in its investment
decision the firm will have to take expected future technologies and future factor prices into account. For
many issues in long-run analysis the clay property ex-post may be less important, since over time adjustment
takes place through new investment.

So, new technology may not increase employment in developing countries ( assuming technology transfer)
in the short run. If the economy moves with relatively higher growth and arrange further investments in
the long run, labour requirement will change. Alternatively, if there is a possibility of diffusion and spill
over, country will try to invest on technological progress on its own.
Two Country Model: Extended Discussion
Production fn Innovator : Country 1

The parameter A1 represents the level of the technology in country 1, but it can also represent various aspects of
government policy— such as taxation, provision of public services, and maintenance of property rights—that
influence productivity in country 1.

Price Demand fn Per capita output

The cost of production of Output per worker, y1, increases with the
Marginal product
each intermediate input, productivity parameter, A1, and the
of X1 j to the price
X1 j , is unity number of products, N1
Profit fn
Wage = MPL
Flow of monopoly profit from sales of
the j th intermediate good in country 1
Present Value and Rate of Return from R&D
The present discounted value of all future profits is the value of the R&D firm, V1. The non-arbitrage condition
requires that the rate of return to purchasing an R&D firm be the same as the rate of return to bonds. The
instantaneous rate of return from buying the firm is the profit rate plus the capital gains that accrue from changes in
the value of the firm

Rate of Return from R&D

The cost of inventing a new product in country 1 is a fixed amount of goods, which we denote by η1.

Let us assume a positive amount of innovation occurs in the equilibrium in country 1, hence, the equilibrium growth
rate is positive.

The free-entry condition implies that if V1, > η1, more and more resources will be allocated to R&D and vice versa.
Hence, at the equilibrium value of the firm, V1= η1. Since η1 is a constant, the value of the firm must be constant over
time. Hence,, and, so the interest rate in country 1 is constant in equilibrium

Equilibrium rate of return

Steady State Situation for Inventor

Consumer-optimization condition

Equilibrium Condition

The preference parameters, ρ and θ, are assumed to be the same in all countries

Country 1 is always in a steady state with the quantities N1, Y1, and C1 all
growing at the constant rate γ1.
Situation in Follower Country
Country 2: Follower

Production Fn

Country 1 is the technological leader and country 2 as the follower.

N2(0)< N1(0). Also assume that the N2 products available in country 2 are a subset of the N1 goods known in
country 1. In the initial setting, country 2 will also not make any new discoveries and will just imitate the
intermediate goods known by country 1

A2 and L2 are also different from Country 1. Differences between A2 and A1 could, reflect differences in
government policies. The total labour input represents the scale over which an intermediate good can be
utilized in production. Thus the gap between L2 and L1 reflects the differences in scale of the two
economies

Input Demand fn From Profit max condition

Imitating Firms
The cost of innovation in country 2, η2, is a constant (which need not equal η1). This assumption means that discoveries of
new types of products do not encounter diminishing returns in either country.

The copying and adaptation of one of country 1’s intermediates for use in country 2 is assumed to entail a lump-sum outlay,
denoted by ν2(t).

Imitation differs from innovation in that the number of goods that can be copied at a point in time is limited to the finite
number that have been discovered elsewhere. Specifically, country 2 can select for imitation only from the uncopied subset
of the N1 goods that are known in country 1. As N2 increases relative to N1, the cost of imitation is likely to rise.

The goods that were easier to imitate would then be copied first, and the cost ν2 that applied at the margin would increase
with the number already imitated
If N2/N1 <1, that is, if not all the intermediates of country 1
Imitation Cost ν2 = ν2(N2/N1) have been copied by country 2, the imitation cost, ν2, tends
to be less than η2 because copying is typically cheaper than
discovery.

But ν2 can exceed η2 when N2/N1 <1 if the remaining pool of

uncopied inventions comprises goods that are difficult to
adapt to country 2.
 The cost of imitation in country 2, ν2, is an
increasing function of N2/N1 and is assumed to
approach the cost of innovation, η2, as N2/N1
approaches 1.

The steady-state value of the imitation cost,

ν*2 , is assumed to be less than η2.

A crucial assumption in the model is that the costs of imitation are nontrivial; that is, innovations cannot be
transferred to other locations at negligible cost.

Mansfield, Schwartz, and Wagner (1981) studied the cost of imitation in the United States for 48 product
innovations that were made in the chemical, drug, electronics, and machinery industries. They found that the cost of
imitation averaged 65 percent of the cost of innovation.

Teece (1977) examined the cost of technology transfer across countries for multinational firms. For 26 cases in chemicals,
petroleum refining, and machinery, he found that the cost averaged 19 percent of total project expenditures. He also found
that the transfer cost declined with measures of experience with the technology being transferred but did not depend on the
level of economic development in the recipient country
 The treatment of imitation in country 2 parallels
the setup for innovation in country 1. The cost
Input Demand incurred for imitation is v2 (t) and after paying it the
agent enjoys a monopoly over the product and
Input Price
charge the price P2j to maximize profit subject to
the demand function

Per Capita Output Substituting the value of X2 in output equation

and then the value of output in profit equation,
Profit Also making wage equals to MPL

Ratio of the per-worker products for the two

Output Ratio Countries depend on productivity difference and
relative value of the number of known varieties of
intermediates

Profit Ratio This ratio also increases with A2/A1. The positive
effect from L2/L1 is a scale benefit. The relevant scale
variable is the total of complementary factor input, Li ,
that the intermediates work with in country i
 where r2(v) is the rate of return in country 2
Present Value under at time t
Continuous case

Rate of Return if ν2 were constant, r2 would be constant and equal to π2/ν2,

If ν2 varies over time, r2 includes the capital-gain term, .With free entry, the monopoly right over an intermediate good
must equal the cost of obtaining it, ν2. If ν2 is rising (because N2/N1 is increasing, the expanding value of the monopoly right
implies a capital gain at the rate . This gain adds to the dividend” term, π2/ν2, to get the full rate of return. This result is
analogous to the case where the cost of R&D to be a function of the number of goods previously discovered.
Steady State Situation

In the steady state, N2 grows at the same rate, γ1, as N1. The ratio N2/N1 therefore equals a constant, denoted (N2/N1)* This
implies that ν2 is also constant in the steady state.

Generally, it follows

In the steady state, the growth rates of Y2 and C2 equal the growth rate of N2, which equals γ1
So,
Since C2 and C1 grow in the long run at the same rate, γ1, and since the preference parameters, ρ and θ, are the same in the
two countries, this implies that

Rate of return equalises

The adjustment of N2/N1 to the value (N2/N1)*

Steady State Situation

The assumption, thus far, is that country 2 never chooses to innovate. This behaviour is optimal for agents in country 2 if
ν2(t)<η2 applies along the entire path. Since ν2 is an increasing function of N2/N1, the required condition (if N2/N1 starts below
its steady-state value) is

Innovation cost is more than imitation cost

Country 2 is intrinsically inferior to country 1 in terms of the indicated combination of productivity parameters, A2/A1,
labour endowments, L2/L1, and costs of innovating, η1/η2

Thus at the equilibrium Country 1 is the perpetual leader and Country 2 is the perpetual follower

As (N2/N1)* <1, the steady-state ratio of per-worker products, (y2/y1)*, is less than one if A2 ≤ A1. (A2 > A1 can be consistent with
the inequality if L2 < L1 or η2 >η1.) Thus the follower country’s per worker output is likely to fall short of the leader’s value
even in the steady state. The potential to imitate does not generally provide a strong enough force to equalize the levels of per-
worker product in the long run.

The follower country also tends to lag behind in the long run in terms of per capita consumption.
Foreign Investment and Patent
In the previous analysis an innovator in country 1 paid the cost η1 to obtain the monopoly right over the use of an
intermediate good in country 1. The innovator obtained no property rights over the use of the intermediate good in country 2.

Now, let us assume that instead that innovators from country 1 have perpetual monopoly rights over the use of their
intermediate goods in both countries. Country 2 is now open for foreign investment and pays to Country 1 the royalty
( respecting IPR).

We assume that the cost of adapting a variety of intermediate good from country 1 to country 2 is the constant ν2.

The cost of adaptation to country 2 is low enough so that country 2 will tend to grow faster than country 1. The entrepreneurs
in country 2 do not find it worthwhile to innovate. Hence, all the innovations and adaptations stem from the efforts of
entrepreneurs from country 1.

If country 2 were suddenly opened up to foreign investment, the number N1 of known products from country 1 would
greatly exceed the number N2 available in country 2.

The rate of return to foreign investment by country 1 in country 2—that is, adaptation of products for use in Country 2—is
given by r2 =π2/ν2. The rate r2 exceeds the rate r1 =π1/η1 for innovation.
The backlog of un-adapted products is eventually eliminated—that is, N2 reaches N1— and the rate of return r2 from pure
adaptation becomes unavailable. The researchers from country 1 are then motivated to direct R&D expenditures to the
discovery of new products, that is, to expand N1

The total flow of monopoly profits from the discovery of a new product in country 1 and the simultaneous adaptation of
this product to country 2

An innovator in country 1 now pays the total cost η1 +ν2 to secure the flow of monopoly profit

The inequality ν2 <ν*2 implies that ˜r1 exceeds the value for r1

N1, Y1, C1, N2, Y2, and C2—all grow at a constant rate given by
What will happen to growth rate of Follower ?
Leapfrogging
Reverse Situation

so that country 2 is intrinsically superior to country 1. Since N2(0)< N1(0) still applies, country 2 again begins in a
technologically inferior state. This situation could arise, for example, if country 2 had been inferior to country 1 for a long
time but a recent improvement in government policy—represented by an increase in A2—made country 2 intrinsically
superior.
The cost of imitation in country 2, ν2, is an increasing
function of N2/N1 and approaches the cost of
innovation, η2, as N2/N1 approaches 1. The steady-state
value of the imitation cost, ν*2 is now assumed to
exceed η2.
As N2/N1 reaches unity and, correspondingly, ν2 reaches η2
at a point where the cost of increasing N2 is still below ν*2 .
This result means that agents in country 2 find it
advantageous to raise N2/N1 above unity by innovating at
the cost η2.

Thus, once all of country 1’s discoveries have been

Brezis, Krugman, and Tsiddon (1993) argue that Great Britain copied, country 2 switches to innovation.
overtook the Netherlands as leader in the 1700s, the United States
overtook Great Britain by the late 1800s, and Japan surpassed the
United States in some sectors by the 1980s
Conclusion

The diffusion of technology from leading economies to followers involves costs of imitation and adaptation.

These costs were lower than those for innovation when little copying had occurred but rose as the pool of uncopied ideas
contracted

Follower countries tend to grow faster the greater the gap from the leaders. This process is, however, conditional, in that
the growth rate depends, for a given technological gap, on government policies and other variables that influence the rate
of return to imitation in a follower economy.

In the steady state, the leading and following countries grow at the same rate. Thus, equalization of growth rates occurs in
the long run even if countries differ in costs of R&D, levels of productivity, and the willingness to save.

If the countries have the same preferences about saving , the equalization of growth rates implies that rates of return are
also the same in the steady state ( rate of return may equalise even without capital flow).

Some countries may through their economic policy may develop skill and capability and in the long run even reach the
position of innovator from follower.