On the strategic choice of innovation type

This note studies the strategic choice between product and process innovation under hard budget constraints. Firms cannot invest in both dimensions, so innovation choices are shaped by strategic interaction as well as private returns. We show that when quality-enhancing innovation becomes sufficiently effective, firms coordinate on a symmetric profile in which both adopt product innovation, even though social welfare is maximized by asymmetric specialization. A minimal ex ante subsidy, targeted to the direction of innovation, is enough to implement the welfare-optimal asymmetric allocation without distorting market competition. The results highlight how simple, directional incentives can correct strategic misalignment in resource-constrained innovation environments.