Introduction

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.

We argued in Aghion and Howitt (1998) that by using Schumpeter’s insights to de­velop a growth model with quality-improving innovations one can provide an integrated framework for understanding not only the macroeconomic structure of growth but also the many microeconomic issues regarding incentives, policies, and institutions that in­teract with growth. Who gains from innovations, who loses, and how, much all depend on institutions and policies. By focusing on these influences in a model where entrepre­neurs introduce new technologies that render previous technologies obsolete we hope to understand why those who would gain from growth prevail in some societies, while in others they are blocked by those who would lose.

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.

The paper is organized as follows. Section 2 develops the basic framework. Sec­tion 3 uses it to analyze convergence and divergence patterns in the cross-country data. Section 4 analyses the interaction between growth and product market competition. Section 5 deals with the scale effect of growing population. Section 6 analyzes the in­terplay between institutional change and technological change, and Section 7 provides some concluding remarks and suggestions for future research.

2.