How Destructive Is Innovation

Daniel Garcia-Macia, Chang-Tai Hsieh and Peter Klenow, "How Destructive Is Innovation," Econometrica, http://klenow.com/DestructiveInnovation_GHK.pdf

Bottomline, “..How much innovation takes the form of creative destruction versus new varieties versus firms improving their own products? How much occurs through entrants versus incumbents? We try to infer the sources of innovation from the employment dynamics of U.S. firms in the nonfarm private sector from 1983 to 2013. We conclude that creative destruction is vital for understanding job destruction and accounts for around one-fourth of growth. Own-product quality improvements by incumbents appear to be the biggest source of growth. Net variety growth contributes much less than quality improvements doOur findings are relevant for innovation policy. According to Atkeson and Burstein (forthcoming), the consumption-equivalent welfare gain from devoting about 1% more of GDP to research every year is between 0.17 and 0.73 percent in a model calibrated similarly to ours (but with endogenous research investments). They estimated the gains would be larger—0.26 to 2.01 percent—if creative destruction played no role in U.S. growth. Creative destruction is a force raising the private return relative to the social return to research, diminishing the gains from promoting research….”

“…. Table IV presents TFP growth due to creative destruction (row 1), new varieties (row 2), and own innovation (row 3). TFP growth due to each source of innovation is the product of arrival rate of innovation and the quality improvement conditional on innovation. We use equation (2) for this calculation.18 The first column shows that TFP growth due to own innovation was about 1% per year in 1983-1993. Growth due to creative destruction was about half that, at 0.44% per year. And new varieties generate growth of 0.23% per year. The rows in Table V show the contribution of each source of innovation to aggregate TFP growth. About 27% of the 1.66% growth rate in the 1983-1993 period comes from creative destruction. Own-variety improvements by incumbents account for 60%. New varieties à la Romer (1990) are the remainder at around 14%.The columns in Table V also decompose aggregate TFP growth into the percentage contribution of entrants versus incumbents using equation (3). In the ten years between 1983 and 1993, incumbents account for 68% of aggregate TFP growth, with entrants contributing the remaining 32%. Aghion, Akcigit, and Howitt (2014) provided complementary evidence for the importance of incumbents based on their share of R&D spending and patents…”

TFP driver estimates, “Table III presents the eight parameter values inferred from the data using the procedure described above. Based on the data moments from 1983 to 1993, we infer a 70% arrival rate of own-variety quality improvements per 5-year period. Conditional on no own innovation, quality improvements through creative destruction occur 30% of the time by other incumbents. Conditional on no own innovation and creative destruction by another incumbent, quality improvement through creative destruction by entrants occur with probability 1. The unconditional probability that a given product improves due to creative destruction by an incumbent is thus 8.9%, and the unconditional probability of creative destruction by an entrant is 21.0%.16 The unconditional probability that a product is improved upon in a 5-year period is thus 100%, of which 69% is from own innovation and 31% is from creative destruction (the latter from entrants or incumbents). The employment-weighted average step size for quality improvements on existing varieties is given by sq = (θ/(θ − (σ − 1)))1/(σ−1). Given that θ = 154 and σ = 4, the average improvement in quality (conditional on innovation) is 7.5%.17 New varieties are only created by entrants, arrive with 12.3% probability per existing variety, and have an average quality that is 31% of the average quality of existing varieties. Overhead costs imply that the average quality of exiting products ψ is 2% of the average quality of existing varieties, and that the probability a variety exits due to overhead cost δo is essentially zero. The net number of varieties thus grows by 12.3% every five years, which matches the growth of total employment and number of firms from 1983 to 1993.

Core of paper, “…Entrants and incumbents can create new products and displace the products of competitors. Incumbents can also improve their existing products. How much of aggregate productivity growth occurs through each of these channels? Using data from the U.S. Longitudinal Business Database on all nonfarm private businesses from 1983 to 2013, we arrive at three main conclusions:First, most growth appears to come from incumbents. We infer this from the modest employment share of entering firms (defined as those less than 5 years old). Second, most growth seems to occur through improvements of existing varieties rather than creation of brand new varieties. Third, own-product improvements by incumbents appear to be more important than creative destruction. We infer this because the distribution of job creation and destruction has thinner tails than implied by a model with a dominant role for creative destruction…”