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INNOVATION, REALLOCATION AND GROWTH

April 2013

Working Paper Number:

CES-13-23

Abstract

We build a model of firm-level innovation, productivity growth and reallocation featuring endogenous entry and exit. A key feature is the selection between high- and low-type firms, which differ in terms of their innovative capacity. We estimate the parameters of the model using detailed US Census micro data on firm-level output, R&D and patenting. The model provides a good fit to the dynamics of firm entry and exit, output and R&D, and its implied elasticities are in the ballpark of a range of micro estimates. We find industrial policy subsidizing either the R&D or the continued operation of incumbents reduces growth and welfare. For example, a subsidy to incumbent R&D equivalent to 53 of GDP reduces welfare by about 1.53 because it deters entry of new high-type firms. On the contrary, substantial improvements (of the order of 53 improvement in welfare) are possible if the continued operation of incumbents is taxed while at the same time R&D by incumbents and new entrants is subsidized. This is because of a strong selection effect: R&D resources (skilled labor) are inefficiently used by low-type incumbent firms. Subsidies to incumbents encourage the survival and expansion of these firms at the expense of potential high-type entrants. We show that optimal policy encourages the exit of low-type firms and supports R&D by high-type incumbents and entry.

Document Tags and Keywords

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:
demand, estimation, estimating, growth, merger, monopolistic, endogenous, recession, innovation, expenditure, patent, subsidy, patenting, gdp, exogenous, innovation productivity, subsidized

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:
Census of Manufactures, Internal Revenue Service, Yale University, Longitudinal Research Database, National Science Foundation, Total Factor Productivity, National Bureau of Economic Research, Harvard University, Federal Reserve Bank, Census Bureau Longitudinal Business Database, Longitudinal Business Database, Michigan Institute for Teaching and Research in Economics, Survey of Industrial Research and Development, Chicago Census Research Data Center, Census of Manufacturing Firms, New York University, Special Sworn Status, European Union, European Commission, Kauffman Foundation, International Trade Research Report

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