Question 5
Read the following passage and answer the given subquestions
These two economists took this idea of “creative destruction” — where innovation leads to gains, but also to the destruction of the incumbents — and created a mathematical model to capture it. They showed, through maths, how technological advancement leads to sustained growth.
The basic assumption is that economies include companies that do research and development to create a product that they can patent, thereby creating a monopoly for them and putting them at the top of the chain. However, a patent can’t stop another company from also investing in R&D and coming up with a new product. If that new product is better, it will replace the incumbent and the profits will now flow to the new company.
The model developed by Mr. Aghion and Mr. Howitt can be used to analyse whether there is an optimal volume of R&D, and therefore to analyse economic growth in a free market scenario where there is no political interference. They found that there were two competing trends that made it difficult to arrive at an answer.
The first trend is that, when a new innovation comes in and replaces another, the benefits from the replaced technology still continue to flow to society, even if the company that developed it is no longer making profits from it. In other words, technology that has been outcompeted has more value for society than for the company that developed it. This makes it imperative that R&D be subsidised so that companies aren’t discouraged from it.
However, the other competing trend is that when a company comes up with an innovation that rises to the top of the chain, it starts receiving the bulk of the profits even though the actual improvement might have been incremental over the older technology. For society, the gain from this new technology is limited because it is only a relatively small improvement over the older technology. In such a scenario, investments into R&D might be too high from a societal point of view. Therefore, under this trend, R&D should not be subsidised. The answer to the question of how much R&D needs to happen will, of course, vary depending on the society and the economy in question. However, Mr. Aghion and Mr. Howitt’s theory can be useful for understanding which measures will be most effective in arriving at the optimum R&D level for sustained growth.
Source: Economics Nobel Prize 2025: How innovation drives economic growth – The Hindu
What is the main goal of the Aghion–Howitt model?
To discourage monopolies in technology
To identify which countries innovate the fastest
To promote government control over innovation
To understand the measures which can determine the optimum R&D level