Specialization in a Knowledge Economy

Abstract: Using firm-level data from the US Census Longitudinal Business Database (LBD), this paper exhibits novel evidence about a wave of specialization experienced by US firms in the 1980s and 1990s. Specifically: 1) Firms, especially innovating ones, decreased production scope, i.e., the number of industries in which they produce. 2) Small firms increased innovation relative to production while large firms increased production relative to innovation. A new hypothesis is proposed to explain these phenomena. Pro-patent reforms in the 1980s and 1990s make firms’ innovations more commodified and tradable. Trading provides another channel for firms to monetize their innovation besides production, especially when innovations are mismatched with a firm’s production. Production scope then contributes less to the value of a firm’s innovation, enabling innovation to shift to small firms with limited production scope. To gauge the importance of the new hypothesis, an endogenous growth model is developed with potential mismatches between innovation and production. Calibrating the model to data suggests that increasing tradability of innovation output can explain 25% of the observed production scope decrease and 58% of the reallocation of innovation activities. It results in a 0.64 percent point increase in the annual economic growth rate. Using regional and firm-level differences in exposure to patent policies, difference-in-difference analysis provides evidence of causality from the pro-patent reforms to firms’ production scope shrinkage.

Yueyuan Ma
Yueyuan Ma
Assistant Professor of Economics