We study the interaction between technological innovation, investment in human capital and child labour. In a two‐stage game, first firms decide on innovation, then households decide on education. In equilibrium the presence of inefficient child labour depends on parameters related to technology, parents' altruism and the diffusion of firms' property. Child labour is due either to firms' reluctance to innovate or to households' unwillingness to educate, or both. In some cases, compulsory schooling laws or a ban on child labour are welfare‐reducing, whereas a subsidy for innovation is the right tool to eliminate child labour and increase welfare.