Knowledge Constraints and Firm Scale
46 Pages Posted: 5 Dec 2017 Last revised: 30 Jan 2020
Date Written: November 30, 2019
I propose a resolution to the high-returns-to-R&D puzzle. The R&D investments of small and medium firms (lower 2/3 of the firm scale distribution) exhibit evidence of bunching below an upper-bound. No such bunching exists for physical investment. I show that a constraint on knowledge accumulation rationalizes this pattern and resolves the R&D puzzle. Structural estimation indicates the constraint is binding for the 20%-25% highest growth R&D-performing small and medium firms. Counter-factual analysis shows slackening the constraint significantly increases firm growth rates and the total size of the economy. A validation test indicates the constraint is related to frictions in human-capital accumulation within firms.
JEL Classification: D2, G31, G32, J24, O32
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