From imitation to innovation: Where is all that Chinese R&D going? (with Michael König and Kjetil Storesletten)

Abstract:
This paper analyzes the extent and effects of misallocation of R&D with the aid of a structural model based on König et al. (2016). The theory predicts that in an efficient environment innovation should be carried out by high-productivity firms while low-productivity firms should focus on adopting technologies from more productive firms. Misallocation arises when, due to some investment wedges, it is less productive firms that invest in R&D. We use China’s firm-level productivity data and R&D data from 2001 and 2007. We find that high-TFP firms are more likely to do R&D, but the allocation of R&D is subject to large distortions. The allocation of R&D expenditure improves between 2001 and 2007, but remains significantly less efficient than the allocation of R&D in Taiwan in the late 1980’s. We also document a persistent misallocation across ownership: state-owned enterprises do too much R&D relative to private firms. We conclude that the misallocation of R&D can have large effects on aggregate productivity growth, and that a reduction in such misallocation can be important in sustaining future economic growth.