Heterogeneous Firms, Growth and the Long Shadows of Business Cycles

Do firms differ in their innovation response to business cycles? What economic forces shape this heterogeneity? And does it matter for aggregate propagation? We document substantial heterogeneity in firm-level R&D cyclicality, develop a theory to explain this fact, and validate its key mechanism in the data. In a tractable model of business cycles and innovation-driven growth, endogenous selection makes R&D particularly responsive to aggregate conditions for firms close to the exit margin. Consistent with this mechanism, firms closer to exit display more procyclical R&D in the data. Quantitatively, selection and endogenous growth interact powerfully: selection generates heterogeneous R&D cyclicality, while endogenous growth translates these heterogeneous responses into persistent aggregate effects. Ignoring heterogeneous R&D cyclicality misses roughly half of the long-run output cost of a severe recession.