Production Networks and R&D Misallocaition

Abstract

This paper investigates the interaction between production networks and firms’ research and development (R&D) decisions and their implications for aggregate inefficiency. Using Japanese inter-firm transaction and patent data, we document that older firms have more network connections and tend to connect with other older firms. Additionally, connected firms’ R&D stimulates innovation in their partner firms. Motivated by these empirical findings, we construct a model that incorporates the dynamics of production networks and R&D as a new variety creation. In this model, firms gradually build their supply chains and can leverage their existing supply chains to develop and sell new products. Our model implies that older firms at the center of the production network underinvest in R&D relative to the optimal allocation.