Profiting from Innovation: Firm Level Evidence on Markups
54 Pages Posted: 22 Jan 2014
Date Written: October 10, 2013
While innovation is argued to create value, private incentives of fi rms to innovate are driven by what part of the value created rms can appropriate. In this paper we explore the relation between innovation and the markups a fi rm is able to extract after innovating. We estimate fi rm-speci c price-cost margins from production data and nd that both product and process innovations are positively related to these markups. Product innovations increase markups on average by 5.1% points by shifting out demand and increasing prices. Process innovation increases markups by 3.8% points due to incomplete pass-through of the cost reductions associated with process innovation. The ability of the fi rm to appropriate returns from innovation through higher markups is affected by the actual type of product and process innovation, the fi rm's patenting and promotion behavior, the age of the fi rm and the competition it faces. Moreover, we show that sustained product innovation has a cumulative effect on the fi rms markup.
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