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 a unique long-term dataset that combines panel data on inter-firm transactions and patent data in Japan, we investigate the relationship between the life cycle of firms’ production networks and R&D. Our findings indicate that production networks are age-dependent, with older firms being more interconnected and their counterparts also aging. Additionally, increased R&D, indicated by the patents of connected firms, stimulates a firm’s own R&D activities. 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.