Recent theories of economic growth treat commercially oriented innovation in response to economic incentives as a major engine of technological progress and productivity growth. In this view, innovation feeds on knowledge arising from cumulative research and development (R&D) experience on the one hand, and it contributes to this stock of knowledge on the other. Consequently, an economy’s level of productivity depends on its cumulative R&D effort and on its effective stock of knowledge, with the two being interrelated.
In a world with international trade in goods and services, foreign direct investment, and international exchange of information, a country’s productivity depends on the R&D of its trade partners as well as on its own. Direct benefits of foreign R&D consist of learning about new technologies and materials, production processes, or organizational methods. Indirect benefits emanate from imports of goods and services that have been developed by trade partners.
The paper studies the extent to which a country’s total factor productivity depends on domestic and foreign R&D capital stocks. For each of the countries in the sample, domestic R&D expenditures are cumulated as a proxy for the R&D capital stock and a foreign R&D capital stock is constructed as the import-weighted sum of the trade partner’s R&D capital stocks. Equations are estimated on a pooled data set of 22 countries during the period 1970-90 and the results interpreted as pooled cointegrating equations.
The paper finds that both domestic and foreign R&D capital stocks have important effects on total factor productivity. While the beneficial effects of domestic R&D on total factor productivity are well established, the evidence of the importance of foreign R&D is new. Estimates suggest that the effect of foreign R&D on domestic productivity is stronger the more open an economy is to foreign trade. In the large countries, the elasticity of total factor productivity with respect to the domestic R&D capital stock is larger than with respect to the foreign R&D capital stock, whereas the reverse is true for some of the small open economies. Estimates also suggest that the rate of return on R&D capital stocks is very high, both in terms of domestic output and in terms of international spillovers.