R-AND-D, INVESTMENT, AND INDUSTRY DYNAMICS

We present a model of industry evolution where the dynamics are driven by a process of endogenous innovations followed by subsequent embodim ents in physical capital. Traditionally, the only distinction between R&D and physical investment was one of labeling: the first process acc umulates an intangible stock, knowledge, while the second accumulates physical capital. Both stocks affect output in a symmetric fashion. We argue that the story is not that simple, and that there is more to it than differences in the object of accumulation. Our model stresses th e causal relationship between past R&D expenditures and current invest ments in machinery and equipment. This causality pattern, which is sup ported by the data, also explains the observed higher volatility of ph ysical investment relative to that of R&D expenditures.