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

In the presence of markup differences, externalities, and other social effects, the direction of innovation can be systematically distorted. I build a simple model of endogenous technology to study distortions in the direction of innovation. Empirical findings across a number of different areas are consistent with this framework's predictions. I use data from several studies to estimate the framework's key parameters and combine them with rough estimates of differential externalities and markups to provide suggestive evidence that innovation distortions can be substantial in the context of industrial automation, health care, and energy, and that correcting them could have sizable welfare benefits.