How do changes in the economic environment such as reductions in international trade costs or reductions in firms' innovation costs impact aggregate productivity? More generally, how do changes in economic policies that affect market size, market structure, and the costs and benefits to firms of innovative activity impact aggregate productivity? There is a very large literature, following from the work of Zvi Griliches and many others, that uses detailed firm-level data to assess the impact of changes in economic policies and changes in other aspects of the economic environment on firms' decisions to exit, export, and engage in innovative activities. Here the PI's propose to develop models of heterogeneous innovating firms in general equilibrium that not only are consistent with the micro data on firms' behavior, but also can be used to aggregate-up from firm-level decisions to obtain a deeper understanding of how aggregate productivity should be expected to respond to changes in the economic environment or economic policy.
Intellectual Merit The PI's develop a collection of models of heterogeneous firms' decisions to exit, export, and investment in both R&D by incumbent firms (which the PI's term process innovation) and in the creation of new firms or products (which they term product innovation). The PI's show that in these models one can use a simple two-step algorithm to assess the impact of a change in the costs of process innovation or a change in the marginal costs of international trade on aggregate productivity in the long run. They show analytically that, when the real interest rate approaches zero, consideration of the endogeneity of firms' decisions to exit, export, and invest in process innovation have no impact, to a first-order approximation, on our models' implications for the long-run impact in general equilibrium of a change in the costs of process innovation or a change in international trade costs on aggregate productivity. This is not to say that there are no important changes in firm dynamics that result from a change in international trade or process innovation costs. In fact, for certain assumptions about the elasticity of incumbent firms' investments in process innovation with regard to changes in the costs or benefits of such innovation, the model predicts very large changes in these firms' innovative efforts and productivity growth rates. When the PI's aggregate, however, they find that, to the extent that changes in heterogeneous firms' exit, export, and process innovation decisions do result in a change in the steady-state level of productivity for the average firm, the impact of these changes in average firm productivity must be offset by a change in the number of firms relative to the number that would arise in steady-state were the average productivity of a firm to remain unchanged. One part of the proposed research is to investigate the extent to which the analytical results can be extended to a much wider array of changes in the economic environment and, more generally, to a much wider array of policies aimed at fostering innovation by firms. In a second part the PI's will explore specifications of the model that include various types of spillovers. In a third part the PI's solve quantitative versions of our model numerically to calculate both the long run response of aggregate productivity and the transition path of the economy from one steady-state to another in those circumstance in which the analytical results do not apply.
Broader Impact: The work will shed light on the links between innovation policies, firms' innovative investments, and the corresponding movements in aggregate productivity.
