Hyunjae Lee

This paper develops a Schumpeterian growth model with endogenous industry dynamics. A continuum of industries is endogenously created, evolves through a life cycle, and eventually exits. Potential entrants choose between joining an existing industry to compete for market share or paying a sunk cost to create a new industry and secure a temporary monopoly. This entry margin governs the balance between intensifying within-industry competition and expanding technological variety, thereby endogenously determining industry turnover and the composition of growth. In Markov-perfect equilibrium, individual industries follow non-stationary life-cycle paths, yet the economy exhibits stationary aggregate growth with continual sectoral rotation. I identify a new set of externalities operating through the industry-creation margin that distort equilibrium entry and innovation incentives. Using quantitative methods, I characterize comparative statics with respect to startup formation and industry-creation costs, and calibrate the model to U.S. data from 1982–2011. The calibrated economy exhibits insufficient industry renewal in equilibrium and, consequently, subsidies targeted at variety creation deliver larger gains in growth and welfare than traditional subsidies to incumbent R&D.