| 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 5% of GDP reduces welfare by about 1.5% because it deters
entry of new high-type firms. On the contrary, substantial improvements (of
the order of 5% 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. |