Technology Choice and Saving in the Presence of a Fixed Adoption Cost Charles Ka Yui Leung and Chung Yi Tse* Abstract This paper explores the relationship between technology choice and saving in the presence of fixed costs of technology adoption. While richer agents adopt the more productive technology immediately it is available, poorer agents optimally choose to wait before switching to the better technology. In the interim, they save more than others and more than in the absence of the prospect of switching to the new technology. The paper thus provides an explanation for the phenomenon that the saving rate and the growth rate of output increase over time in the transition. 1. Introduction Adopting a new technology is costly. When old machines are scrapped, there is a dis- crete drop in the capital available. If the cost of adopting the more advanced technol- ogy is sufficiently high, poor agents and countries alike may continue using the less productive technology despite the availability of the more productive alternative. 1 In this paper, we study a model of costly technology adoption with endogenous saving behavior.While previous investigations (e.g., Jones, 1979; Marjit, 1988, 1992, 1994) have explored the relationship between the fixed cost and technology choice, they did not model saving behavior explicitly. 2 In the model considered here, agents decide whether (and when) to adopt the more productive technology, as well as selecting the optimal consumption and saving paths in the interim. We modify the standard endogenous growth model developed in Rebelo (1991) to allow for endogenous timing of technology adoption. For simplicity, we rule out borrowing and lending altogether. This assumption is perhaps more relevant in prac- tice than the opposite extreme of a perfect capital market. Undoubtedly, capital markets are far from perfect even in developed countries, and the problem is all the more acute in developing ones. In the analysis that follows, we will restrict attention to the case where there is a single advanced technology to adopt. In practice, technology adoption is better described as a continuous process with better technologies becoming available from time to time. Our analysis can be readily generalized to this more realistic situation, but the intuition is easier to explain in a model with a single technology to adopt. The defining characteristic of a dynamic model of technology adoption is regime switching, from a low-productivity regime to a high-productivity one.With endogenous saving behavior, we show that the nonconvexity from regime switching gives rise to an increased saving rate and growth rate of output in the transition to the new technology. Indeed the path of the increasing saving rate is not continuous and could Review of Development Economics, 5(1), 40–48, 2001 © Blackwell Publishers Ltd 2001, 108 Cowley Road, Oxford OX4 1JF, UK and 350 Main Street, Malden, MA 02148, USA *Leung: Chinese University of Hong Kong, Shatin, Hong Kong, China.Tel: (852) 2609-7158; Fax: (852) 2603- 5805; E-mail: charlesl@cuhk.edu.hk.Tse: University of Hong Kong, Pokfulam Road, Hong Kong, China.Tel: 852-2859-1035; Fax: 2548-1152; E-mail: tsechung@econ.hku.hk. The authors are very grateful to Valerie Bencivenga, William Liu, Priscilla Ng, the anonymous referees, participants of Chinese University Brown Bag, and especially Chi Chur Chao, E. Kwan Choi, Sugata Marjit, and Bruce Smith for helpful comments. Tse gratefully acknowledges financial support from HKU URC grant 7157/98H.The usual disclaimer applies.