Distorted Innovation: Does the Market Get the Direction of Technology Right

In the presence of markup differences and externalities, the equilibrium direction of innovation can be systematically distorted. I build a simple model of endogenous technology, which generalizes existing comparative statics and characterizes distortions in the direction of innovation. Empirical findings across a number of areas are consistent with this framework's predictions, and I use data from several studies to estimate its key parameters. Combining these numbers with estimates of externalities and markups, I find that equilibrium distortions in the direction of technology can be substantial and have large welfare costs in the context of industrial automation, health care, and energy.