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Substitution and Returns to Scale in R&D

We build a quality ladders product cycle model with Northern innovation, Northern imitation, and Southern imitation. Our model generalizes Segerstrom (1991) to allow Southern imitation and Grossman and Helpman (1991a) to allow Northern imitation. We show how changes in resources, resource requirements in R&D, and R&D subsidies generate substitution in Northern R&D between innovation and imitation and substitution in imitation between the North and the South. We demonstrate that an increase in the difficulty of innovation can generate seemingly decreasing returns to scale in Northern R&D: innovation remaining constant despite an expansion in the resources employed in Northern R&D.