Research Interests: Macroeconomics, Economic Growth, Firm Dynamics, Innovation, Entrepreneurship.



Abstract: We examine the golden age of U.S. innovation by undertaking a major data collection exercise linking inventors from historical U.S. patents to Federal Censuses between 1880 and 1940 and to regional economic aggregates. We provide a theoretical framework to motivate the micro and macro-level stylized facts we uncover in the data. We show that inventors were highly educated and that father's income and education were important intergenerational transmission channels. Inventors tended to migrate to places that were conducive to innovation and they were positively selected through exit early in their careers. New inventors received more patent citations than incumbent inventors, suggesting a cycle of creative destruction. The financial returns to technological development were high. At the macro-level we identify a strong relationship between patented inventions and long-run economic growth, and use an instrumental variables approach exploiting an historical shift in innovation activity during World War II to show that this relationship could be causal. Finally, we document a U-shaped relationship between top income inequality and innovation, yet innovative places tended to be more socially mobile. Our new data help to address important questions related to innovation and long-run growth dynamics.

Abstract: Do political connections affect firm and industry dynamics? We study the Italian firms and their workers to answer this question. Our analysis uses a brand-new data spanning the period from 1993 to 2014 where we merge: (i) firm-level balance sheet data, (ii) universe of social security data on workers, (iii) patent data from the European Patent Office, (iv) registry of local politicians, and (v) detailed data on local elections in Italy.  We find that firm-level political connections are widespread, especially among large firms, and that the industries with more politically connected firms feature worse firm dynamics. Market leaders are much more likely to hire a politician and less likely to innovate, compared to their competitors. In addition, connections relate to higher survival and growth in employment and sales but not in productivity. We build a firm dynamics model where we allow firms to invest in innovation and/or political connections to advance their productivity and to overcome regulatory or bureaucratic burden. The model highlights the new  interaction between static gains and dynamic losses from rent-seeking for aggregate productivity.

Economic Growth: The Past, the Present, and the Future

Commemorative Essay in "The Past, Present, and Future of Economics: A Celebration of the 125 Year Anniversary of the JPE and Chicago Economics," Edited by John List and Harald Uhlig.

Journal of Political Economy, 2017, 125(6): 1736-47.

Abstract: What are the roles of human capital, fertility,  ideas, basic science, and public policy for growth? These are just some of the important questions that were posed by many highly influential studies featured in the issues of the Journal of Political Economy over the years.  In this paper, I revisit some of those  seminal J.P.E. papers in the field of economic growth, briefly describe some of the more recent contributions, and end with some thoughts about the future direction of the field.

The Social Origins of Inventors

(w/ Philippe Aghion, Ari Hyytinen and Otto Toivanen)

NBER Working Paper #24110

CEPR Discussion Paper #12496

Read more at: Project Syndicate, Harvard Business Review

Abstract: In this paper we merge three datasets - individual income data, patenting data, and IQ data - to analyze the determinants of an individual's probability of inventing. We find that: (i) parental income matters even after controlling for other background variables and for IQ, yet the estimated impact of parental income is greatly diminished once parental education and the individual's IQ are controlled for; (ii) IQ has both a direct  effect on the probability of inventing an indirect impact through education. The effect of IQ is larger for inventors than for medical doctors or lawyers. The impact of IQ is robust to controlling for unobserved family characteristics by focusing on potential inventors with brothers close in age. We also provide evidence on the importance of social family interactions, by looking at biological versus non-biological parents. Finally, we find a positive and significant interaction effect between IQ and father income, which suggests a misallocation of talents to innovation.

On the Returns to Invention within Firms: Evidence from Finland

(w/ Philippe Aghion, Ari Hyytinen and Otto Toivanen)

American Economic Review, Papers and Proceedings, May 2018, forthcoming.

Abstract: In this paper we merge individual income data, firm-level data, patenting data and IQ data in Finland over the period 1988-2012 to analyze the returns to invention for inventors and their co-workers or stakeholders within the same firm. We find that: (i) inventors collect only 8% of the total private return from invention; (ii) entrepreneurs get over 44% of the total gains; (iii) bluecollar workers get about 26% of the gains and the rest goes to whitecollar workers. Moreover, entrepreneurs start with significant negative returns prior to the patent application, but their returns subsequently become highly positive.

Immigration and the Rise of American Ingenuity

(w/ John Grigsby and Tom Nicholas)

American Economic Review, Papers and Proceedings, 2017, 107(5): 327-331.

Read more at: The Atlantic, Harvard Business Review, VoxEU, NBER Digest, BizEd Magazine, Les Echos

Abstract: We build on the analysis in Akcigit, Grigsby, Nicholas (2017) by using US patent and Census data to examine the relationship between immigration and innovation. We construct a measure of foreign born expertise and show that technology areas where immigrant inventors were prevalent between 1880 and 1940 experienced more patenting and citations between 1940 and 2000. The contribution of immigrant inventors to US innovation was substantial. We also show that immigrant inventors were more productive than native born inventors; however they received significantly lower levels of labor income. The immigrant inventor wage-gap cannot be explained by differentials in productivity.

Innovation and Trade Policy in a Globalized World

(w/ Sina Ates and Giammario Impullitti)

Abstract: We assess the effects of import tariffs and R&D subsidies as policy responses to foreign technological competition. To this end, we build a dynamic general equilibrium growth model where firm innovation shapes the dynamics of technology endogenously, and, therefore, market leadership and trade flows, in a world with two large open economies at different stages of development. The model accounts for competitive pressures exerted by both entrant and incumbent firms. Firms' R&D decisions are driven by (i) the defensive innovation motive, (ii) the expansionary innovation motive, and (iii) technology spillovers. The theoretical investigation illustrates that, statically, globalization (defined as reduced trade barriers) has ambiguous effect on welfare, while, dynamically, intensified globalization boosts domestic innovation through induced international competition. A calibrated version of the model reproduces the foreign technological catch-up the U.S. experienced during the 1970s and early 1980s. Accounting for transitional dynamics, we use our model for policy evaluation and compute optimal policies over different time horizons. The model suggests that the introduction of the Research and Experimentation Tax Credit in 1981 proves to be an effective policy response to foreign competition, generating substantial welfare gains in the long run. A counterfactual exercise shows that increasing trade barriers as an alternative policy response produces gains only in the very short run, and only when introduced unilaterally, while leading to large losses in the medium and long run. Protectionist measures generate large dynamic losses from trade, distorting the impact of openness on innovation incentives and productivity growth. Finally, we show that less government intervention is needed in a globalized world, thanks to intensified international competition as a result of lower trade barriers.

Optimal Taxation and R&D Policies

(w/ Douglas Hanley and Stefanie Stantcheva)

NBER Working Paper #22908

Revise and Resubmit, Econometrica.

Abstract: We study the optimal design of R&D policies and corporate taxation as a dynamic mechanism design with externalities using the tools of public economics. Firms are heterogeneous in their research productivity, i.e., in the efficiency with which they convert a given set of R&D inputs into successful innovations. There are non-internalized technology spillovers across firms, but the asymmetric information about firms' research productivity prevents the first best solution. We characterize the optimal policies for firms of different sizes and ages. We highlight that key parameters for these policies are i) the relative complementarities between observable R&D investments, unobservable R&D inputs, and firm productivity, and ii) the dispersion and persistence of firm productivity. We estimate our model using firm-level data matched to patent data and quantify the optimal policies. Simpler innovation policies, such as linear R&D subsidies and linear profit taxes, lead to large revenue losses relative to the optimal mechanism. Our formulas and theoretical and numerical methods are more broadly applicable to the provision of firm incentives in dynamic settings with asymmetric information and spillovers.

Back to Basics: Basic Research Spillovers, Innovation Policy and Growth

(w/ Douglas Hanley and Nicolas Serrano-Velarde)

CEPR Discussion Paper #11707

Revise and Resubmit, Review of Economic Studies

Abstract: This paper introduces a general equilibrium model of endogenous technical change through basic and applied research. Basic research differs from applied research in the nature and the magnitude of the generated spillovers. We propose a novel way of empirically identifying these spillovers and embed them in a framework with private firms and a public research sector. After characterizing the equilibrium, we estimate our model using micro-level data on research expenditures by French firms. Our key finding is that standard innovation policies (e.g., uniform R&D tax credits) can accentuate the dynamic misallocation in the economy by oversubsidizing applied research. Policies geared towards public basic research and its transmission to the private sector are significantly welfare improving.

Lack of Selection and Limits to Delegation: Firm Dynamics in Developing Countries

(w/ Harun Alp and Michael Peters)

NBER Working Paper #21905

Abstract: Firm dynamics in developing countries show striking differences to those in developed countries. While some firms do grow as they age, most firms are simply stagnant and do not exit despite being small. We ask to what extent these patterns could be driven by cross-country differences in the efficiency of managerial delegation. If delegating managerial tasks is difficult in poor countries, entrepreneurs with growth potential might decide to remain small, as they have to rely on their own scarce time to run their daily operations. This in turn reduces competition, slows down firm selection through creative destruction, and hence keeps subsistence firms with little growth potential in the market. To quantify the importance of this mechanism, we construct a model of firm growth and calibrate it to firm-level data from the U.S. and India. Three results emerge: (i) The Indian economy suffers from a lack of selection, whereby a low rate of creative destruction allows subsistence producers to survive. (ii) The high delegation efficiency in the U.S. is an important determinant of why U.S. firms are large. (iii) While managerial delegation is inefficient in India, its effect on the lifecycle of Indian firms is limited due to important complementarities between the delegation efficiency and other factors affecting firm growth.

Tax Simplicity and Heterogeneous Learning

(w/ Philippe Aghion, Matthieu Lequien, Stefanie Stantcheva)

NBER Working Paper #24049.

Read more at: Washington Post

Abstract. We study how strongly individuals respond to tax simplicity and how they learn about the complexities of the tax system.  We focus on the self-employed, who can more easily adjust to tax incentives and whose responses directly stem from their own understanding of the tax system. We use new French tax returns data from 1994 to 2012. France serves as a good quasi-laboratory: it has three fiscal regimes -- or modes of taxation-- for the self-employed, which differ in their monetary tax incentives and in their tax simplicity. Two key features are that, first, these regimes are subject to eligibility thresholds; we find large excess masses (bunching) right below the latter. Second, the regimes impact different agents heterogeneously and have changed extensively over time. Taken together, these two key elements give us measures of tax responses (the bunching) as well as the variation needed to jointly estimate a value of tax simplicity and taxable income elasticities. They also give us an opportunity to study how individuals learn about and respond over time to changing policy parameters.
We estimate a large value for tax simplicity of up to 650 euros per year per individual depending on the regime and activity. We also find sizable costs of tax complexity; agents are not immediately able to understand what the right regime choice is, leave significant money on the table, and learn over time. The cost of complexity is "regressive" in that it affects mostly the uneducated, low income, and low skill agents.
Agents who can be viewed as more informed and knowledgable (e.g., the more educated or high-skilled) are more likely to make the correct regime choice and to learn faster.

Growth through Heterogeneous Innovations

(w/ William Kerr)

Journal of Political Economy, forthcoming.

Abstract:  We study how external versus internal innovations promote economic growth through a tractable endogenous growth framework with multiple innovation sizes, multi-product firms, and entry/exit. Firms invest in external R&D to acquire new product lines and in internal R&D to improve their existing product lines. A baseline model derives the theoretical implications of weaker scaling for external R&D versus internal R&D, and the resulting predictions align with observed empirical regularities for innovative firms. Quantifying a generalized model for the recent U.S. economy using matched Census Bureau and patent data, we observe a modest departure for external R&D from perfect scaling frameworks.

Taxation and the International Mobility of Inventors

(w/ Salome Baslandze and Stefanie Stantcheva)

American Economic Review, 2016, 106(10): 2930-81.

Read more at: The Wall Street Journal, The Telegraph, The Telegraph (Comment), VoxEU, NBER Digest, Microeconomic Insights.

Abstract: This paper studies the effect of top tax rates on inventors' mobility across OECD countries since 1977. We put special emphasis on "superstar'' inventors, those with the most and most valuable patents. We use data on inventors from the United States Patent Office to track inventors' locations over time and combine it with international effective top tax rate data. We construct a detailed set of proxies for inventors' counterfactual incomes in each possible destination country including, among others, measures of patent quality and technological fit with each potential destination. We find that superstar top 1% inventors are significantly affected by top taxes rates when deciding on where to locate. The elasticity of domestic inventors to the net-of-tax rate is 0.04, while the elasticity of foreign inventors is 1.3. The elasticities to top net-of-tax rates decline as one moves down the quality distribution of inventors. Inventors who have worked in multinational companies are more likely to take advantage of tax differentials. On the other hand, if the company of an inventor has a higher share of its research activity in a given country, the inventor is less sensitive to the tax rate in that country. We perform extensive robustness checks, including using an alternative dataset based on European Patent Office filings.

Innovation Network

(w/ Daron Acemoglu and William Kerr)

Proceedings of the National Academy of Sciences, 2016, 113(41): 11483–11488.

Read more at: VoxEU

Abstract: Technological progress builds upon itself, with the expansion of invention in one domain propelling future work in linked fields. Our analysis uses 1.8 million U.S. patents and their citation properties to map the innovation network and its strength. Past innovation network structures are calculated using citation patterns across technology classes during 1975--1994. The interaction of this pre-existing network structure with patent growth in upstream technology fields has strong predictive power on future innovation after 1995. This pattern is consistent with the idea that when there is more past upstream innovation for a particular technology class to build on, then that technology class innovates more.

Creative Destruction and Subjective Wellbeing

(w/ Philippe Aghion, Angus Deaton and Alexandra Roulet)

American Economic Review, 2016, 106(12): 3869-3897.

(Click here for the Online Appendix)

Read more at: American Economic Association.

Abstract: In this paper we analyze the relationship between turnover-driven growth and subjective wellbeing. Our model of innovation-led growth and unemployment predicts that: (i) the effect of creative destruction on expected individual welfare should be unambiguously positive if we control for unemployment, less so if we do not; (ii) job creation has a positive and job destruction has a negative impact on wellbeing; (iii) job destruction has a less negative impact in US Metropolitan Statistical Areas (MSA) within states with more generous unemployment insurance policies; (iv) job creation has a more positive effect on individuals that are more forward-looking. The empirical analysis using cross-sectional MSA-level and individual-level data provides empirical support to these predictions.

Transition to Clean Technology

(w/ Daron Acemoglu, Douglas Hanley and William Kerr)

Journal of Political Economy, 2016, 124(1): 52-104.

Read more at: VoxEU

Abstract: We develop a microeconomic model of endogenous growth where clean and dirty technologies compete in production and innovation -in the sense that research can be directed to either clean or dirty technologies. If dirty technologies are more advanced to start with, the potential transition to clean technology can be difficult both because clean research must climb several steps to catch up with dirty technology and because this gap discourages research effort directed towards clean technologies. Carbon taxes and research subsidies may nonetheless encourage production and innovation in clean technologies, though the transition will typically be slow. We characterize certain general properties of the transition path from dirty to clean technology. We then estimate the model using a combination of regression analysis on the relationship between R&D and patents, and simulated method of moments using microdata on employment, production, R&D, firm growth, entry and exit from the US energy sector. The model's quantitative implications match a range of moments not targeted in the estimation quite well. We then characterize the optimal policy path implied by the model and our estimates. Optimal policy heavily relies on research subsidies as well as carbon taxes. We use the model to evaluate the welfare consequences of a range of alternative policy structures. For example, just relying on carbon taxes or delaying intervention both have significant welfare costs -though their implications for medium run temperature increases are quite different.

Abstract:  An endogenous growth model is developed where each period firms invest in researching and developing new ideas. An idea increases a firm's productivity. By how much depends on how central the idea is to a firm's activity. Ideas can be bought and sold on a market for patents. A firm can sell an idea that is not relevant to its business or buy one if it fails to innovate. The developed model is matched up with stylized facts about the market for patents in the U.S. The analysis attempts to gauge how efficiency in the patent market affects growth.

Innovation, Reallocation and Growth

(w/ Daron Acemoglu, Harun Alp, Nicholas Bloom and William Kerr)

CEPR Discussion Paper #12449
NBER Working Paper #18993

Revise and Resubmit, American Economic Review

Abstract: We build a model of firm-level innovation, productivity growth and reallocation featuring endogenous entry and exit. A new and central economic force is the selection between high- and low-type firms, which differ in terms of their innovative capacity. We estimate the parameters of the model using US Census micro data on firm-level output, R&D and patenting. The model provides a good fit to the dynamics of firm entry and exit, output and R&D. Taxing the continued operation of incumbents can lead to sizable gains (of the order of 1.4% improvement in welfare) by encouraging exit of less productive firms and freeing up skilled labor to be used for R&D by high-type incumbents. Subsidies to the R&D of incumbents do not achieve this objective because they encourage the survival and expansion of low-type firms.

Innovation and Top Income Inequality

(w/ Philippe Aghion, Antonin Bergeaud, Richard Blundell, and David Hemous)

NBER Working Paper #21247

Read more at: VoxEU, US News

Revise and Resubmit, Review of Economic Studies.

Abstract: In this paper we use cross-state panel data to show a positive and signi cant correlation between various measures of innovativeness and top income inequality in the United States over the past decades. Two distinct instrumentation strategies suggest that this correlation (partly) reflects a causality from innovativeness to top income inequality, and the effect is signi cant: for example, when measured by the number of patent per capita, innovativeness accounts on average across US states for around 17% of the total increase in the top 1% income share between 1975 and 2010. Yet, innovation does not appear to increase other measures of inequality which do not focus on top incomes. Next, we show that the positive effects of innovation on the top 1% income share are dampened in states with higher lobbying intensity. Finally, from cross-section regressions performed at the commuting zone (CZ) level, we find that: (i) innovativeness is positively correlated with upward social mobility; (ii) the positive correlation between innovativeness and social mobility, is driven mainly by entrant innovators and less so by incumbent innovators, and it is dampened in states with higher lobbying intensity. Overall, our findings vindicate the Schumpeterian view whereby the rise in top income shares is partly related to innovation-led growth, where innovation itself fosters social mobility at the top through creative destruction.

The Role of Information in Innovation and Competition

(w/ Qingmin Liu)

(Click here for the Online Appendix)

Journal of the European Economic Association, 2016, 14(4): 828-870.

Abstract:  Innovation is typically a trial-and-error process. While some research paths lead to the innovation sought, others result in dead ends. Because firms benefit from their competitors working in the wrong direction, they do not reveal their dead-end findings. Time and resources are wasted on projects that other firms have already found to be fruitless. This is a major problem, particularly in industries that rely heavily on trial-and-error research. We offer a simple model with two firms and two research lines to study this prevalent problem. We characterize the equilibrium in a decentralized environment that necessarily entails significant efficiency losses due to wasteful dead-end replication and a flight to safety -an early abandonment of the risky project. We show that different types of firms follow different innovation strategies and create different kinds of welfare losses. In an extension of the core model, we also study a centralized mechanism whereby firms are incentivized to disclose their actions and share their private information in a timely manner.

Networks and the Macroeconomy: An Empirical Exploration

(w/ Daron Acemoglu and William Kerr)

NBER Macro Annual 2015, ed. by Martin Eichenbaum and Jonathan Parker, 2016, Vol 30: 276-335.

Read more at: Bloomberg

Abstract: The propagation of macroeconomic shocks through input-output and geographic networks can be a powerful driver of macroeconomic fluctuations. We first exposit that in the presence of Cobb-Douglas production functions and consumer preferences, there is a specific pattern of economic transmission whereby demand-side shocks propagate upstream (to input supplying industries) and supply-side shocks propagate downstream (to customer industries) and that there is a tight relationship between the direct impact of a shock and the magnitudes of the downstream and the upstream indirect effects. We then investigate the short-run propagation of four different types of industry-level shocks: two demand-side ones (the exogenous component of the variation in industry imports from China and changes in federal spending) and two supply-side ones (TFP shocks and variation in knowledge/ideas coming from foreign patenting). In each case, we find substantial propagation of these shocks through the input-output network, with a pattern broadly consistent with theory. Quantitatively, the network-based propagation is larger than the direct effects of the shocks, sometimes by severalfold. We also show quantitatively large effects from the geographic network, capturing the fact that the local propagation of a shock to an industry will fall more heavily on other industries that tend to collocate with it across local markets. Our results suggest that the transmission of various different types of shocks through economic networks and industry interlinkages could have first-order implications for the macroeconomy.

Young, Restless, and Creative: Openness to Disruption and Creative Innovations

(w/ Daron Acemoglu and Murat Alp Celik)

NBER Working Paper #19894


Abstract: This paper argues that openness to new, unconventional and disruptive ideas has a first-order impact on creative innovations -innovations that break new ground in terms of knowledge creation. After presenting a motivating model focusing on the choice between incremental and radical innovation, and on how managers of different ages and human capital are sorted across different types of firms, we provide cross-country, firm-level and patent-level evidence consistent with this pattern. Our measures of creative innovations proxy for innovation quality (average number of citations per patent) and creativity (fraction of superstar innovators, the likelihood of a very high number of citations, and generality of patents). Our main proxy for openness to disruption is manager age. This variable is based on the idea that only companies or societies open to such disruption will allow the young to rise up within the hierarchy. Using this proxy at the firm, patent and country level, we present robust evidence that openness to disruption is associated with more creative innovations.

Patent Value and Citations: Creative Destruction or Strategic Disruption?

(w/ David S. Abrams and Jillian Popadak)

NBER Working Paper #19647

Abstract:  Prior work suggests that more valuable patents are cited more and this view has become standard in the empirical innovation literature. Using an NPE-derived dataset with patent-specific revenues we find that the relationship of citations to value in fact forms an inverted-U, with fewer citations at the high end of value than in the middle. Since the value of patents is concentrated in those at the high end, this is a challenge to both the empirical literature and the intuition behind it. We attempt to explain this relationship with a simple model of innovation, allowing for both productive and strategic patents. We find evidence of greater use of strategic patents where it would be most expected: among corporations, in fields of rapid development, in more recent patents and where divisional and continuation applications are employed. These findings have important implications for our basic understanding of growth, innovation, and intellectual property policy.

What Do We Learn from Schumpeterian Growth Theory?

(w/ Philippe Aghion and Peter Howitt)

in Handbook of Economic Growth, ed. by P. Aghion and S. N. Durlauf, 2014, Vol.2: 515-563.

Abstract: Schumpeterian growth theory has operationalized Schumpeter's notion of creative destruction by developing models based on this concept. These models shed light on several aspects of the growth process that could not be properly addressed by alternative theories. In this survey, we focus on four important aspects, namely: (i) the role of competition and market structure; (ii) firm dynamics; (iii) the relationship between growth and development with the notion of appropriate growth institutions; and (iv) the emergence and impact of long-term technological waves. In each case Schumpeterian growth theory delivers predictions that distinguish it from other growth models and which can be tested using micro data.

Optimal Capital Versus Labor Taxation with Innovation-Led Growth

(w/ Philippe Aghion and Jesus Fernandez-Villaverde)

NBER Working Paper #19086

Abstract: Chamley (1986) and Judd (1985) showed that, in a standard neoclassical growth model with capital accumulation and infinitely lived agents, either taxing or subsidizing capital cannot be optimal in the steady state. In this paper, we introduce innovation-led growth into the Chamley-Judd framework, using a Schumpeterian growth model where productivity-enhancing innovations result from profit-motivated R&D investment. Our main result is that, for a given required trend of public expenditure, a zero tax/subsidy on capital becomes suboptimal. In particular, the higher the level of public expenditure and the income elasticity of labor supply, the less should capital income be subsidized and the more it should be taxed. Not taxing capital implies that labor must be taxed at a higher rate. This in turn has a detrimental effect on labor supply and therefore on the market size for innovation. At the same time, for a given labor supply, taxing capital also reduces innovation incentives, so that for low levels of public expenditure and/or labor supply elasticity it becomes optimal to subsidize capital income.

Intellectual Property Rights Policy, Competition and Innovation

(w/ Daron Acemoglu)

Journal of the European Economic Association, 2012, 10(1): 1-42.

(Click for the Online Appendix)

Abstract: To what extent and in what form should the intellectual property rights (IPR) of innovators be protected? Should a company with a large technology lead over its rivals receive the same IPR protection as a company with a more limited advantage? The analysis of these questions necessitates a dynamic framework for the study of the interactions between IPR and competition, in particular to understand the impact of such policies on future incentives. In this paper, we develop such a framework. The economy consists of many industries and firms engaged in cumulative (step-by-step) innovation. IPR policy regulates whether followers in an industry can copy (or license or build upon) the technology of the leader. With full patent protection, followers can catch up to the leader in their industry only by making the same innovation(s) themselves (or by full licensing). We prove the existence of a steady-state equilibrium in a baseline environment and characterize some of its properties. We then quantitatively investigate the implications of different types of IPR policy on the equilibrium growth rate and welfare. The most important result from this exercise is that full patent protection is not optimal (welfare maximizing); instead, optimal policy involves state-dependent IPR protection, providing greater protection to technology leaders that are further ahead than those that are close to their followers. This form of the optimal policy results from the impact of policy on dynamic incentives, in particular from a form of trickle-down effect: providing greater protection to firms that are further ahead of their followers than a certain threshold increases the R&D incentives also for all technology leaders that are less advanced than this threshold.