A Structural Empirical Model of R&D Investment, Firm Heterogeneity, and Industry Evolution

Abstract

This paper develops and estimates an industry equilibrium model of manufacturing plants in the Korean electric motor industry from 1991 to 1996. Plant-level decisions on R&D, physical capital investment, entry, and exit are integrated in a dynamic setting with knowledge spillovers. We use a simulated method of moments estimator and the novel approximation method of Weintraub, Benkard and Van Roy (2008) to estimate the R&D cost, magnitude of knowledge spillovers, adjustment costs of physical investment, and plant scrap value distribution. Knowledge spillovers are essential to explaining the firm-level productivity evolution and the equilibrium market configuration. A counterfactual experiment reveals that a 15% R&D subsidy maximizes industry output and is broadly consistent with a past policy initiative of the Korean government.