The R&D Productivity Puzzle: Innovation Networks with Heterogeneous Firms

TL;DR

This paper models how heterogeneous R&D productivity among firms influences network formation, revealing that large productivity gaps lead to stable, clustered networks with complex welfare implications, challenging traditional assumptions about innovation efficiency.

Contribution

It introduces heterogeneity in R&D productivity into network formation models, showing how it causes asymmetric collaboration benefits and leads to stable, clustered networks with welfare trade-offs.

Findings

Heterogeneous productivity creates asymmetric collaboration gains.

Large productivity gaps destabilize complete networks, favoring clustered structures.

Higher average productivity can reduce welfare due to network effects.

Abstract

We introduce heterogeneous R&D productivities into an endogenous R&D network formation model, generalizing the framework of Goyal and Moraga-Gonz\'alez (2001). Heterogeneous productivities endogenously create asymmetric gains from collaboration: less productive firms benefit disproportionately from links, while more productive firms exert greater R&D effort and incur higher costs. When productivity gaps are sufficiently large, more productive firms experience lower profits from collaborating with less productive partners. As a result, the complete network -- stable under homogeneity -- becomes unstable, and the positive assortative (PA) network, in which firms cluster by R&D productivity, emerges as pairwise stable. Using simulations, we show that the clustered structure delivers higher welfare than the complete network; nevertheless, welfare under this formation follows an inverted U-shape as the fraction of high-productivity firms increases, reflecting crowding-out effects at high fractions. Altogether, we uncover an R&D productivity puzzle: economies with higher average R&D productivity may exhibit lower welfare through (i) the formation of alternative stable networks, or (ii) a crowding-out effect of high-productivity firms. Our findings show that productivity gaps shape the organization of innovation by altering equilibrium R&D alliances and effort. Productivity-enhancing policies must therefore account for these endogenous responses, as they may reverse intended welfare gains.