Endogenous Capital- and Labor-Augmenting Technical Change in the Neoclassical Growth Model

The determinants of the direction of technical change and their implications for
economic growth and economic policy are studied in the one-sector neoclassical growth
model of Ramsey, Cass, and Koopmans extended to allow for endogenous capital- and
labor-augmenting technical change. We develop a novel micro-foundation for the competitive
production sector that rests on the idea that the fabrication of output requires
tasks to be performed by capital and labor. Firms may engage in innovation investments
that increase the productivity of capital and labor in the performance of their respective
tasks. These investments are associated with new technological knowledge that accumulates
over time and sustains long-run growth. We show that the equilibrium allocation
is not Pareto-efficient since both forms of technical change give rise to an inter-temporal
knowledge externality. An appropriate policy of investment subsidies may implement
the efficient allocation.