SEMINAR 23 April 2012: Frederic Michel Patrick Warzynski, Aarhus School of Business

The Impact of Research and Development on Quality, Productivity and Welfare

Abstract

Research and Development is an important source of long run growth and there is a large theoretical literature that shows there may be too little or too much R&D from the social planner’s perspective. In this paper, we provide a methodology for answering this question that jointly studies production and demand for multi-product firms using detailed transaction level dataset from Denmark. Our supply approach combines the proxy techniques of Olley and Pakes (1996), Levinsohn and Petrin (2003) and Ackerberg, Caves and Frazier (2006) using physical quantity data at the firm-product level together.  Our demand approach modifies insights from Berry (1994) and Berry Levinsohn, and Pakes (1995). We generate firm-product level estimates of productivity, markup and product quality.  We relate our estimates to R&D decisions of firms and find that product quality is positively related to product R&D, while productivity is positively related to process R&D. We then conduct a simple experiment and simulate how welfare would increase if firms were to increase R&D investment by 1%. We find that, in most industries, too little R&D is being done from the perspective of society.  In contrast, from the perspective of firms there is sufficient spending on R&D.  Our findings are consistent with a world in which firms cannibalize each other’s profits and are thus not able to recoup enough of the value of their innovations to justify further investment.