Economic Growth when Knowledge is Concentrated

Firms' innovation outcomes depend on their ability to attract and retain talented inventors. What market frictions prevent the sorting between firms with high innovation potential and high-productivity inventors? How does this sorting impact aggregate innovation, growth and welfare? We address these questions both empirically and theoretically. Empirically, we show that firms facing strong competition in the product market employ more productive inventors, while less productive inventors tend to be allocated in concentrated industries. Theoretically, we embed a frictional labor market for inventors into an endogenous-growth model of strategic innovation. In line with the data, the model predicts that high-productivity inventors are disproportionately employed in firms that operate in competitive industries. We then use the model to quantify the growth and welfare implications of this inventor sorting. Our results show that matching frictions in the market for inventors impede the allocation of high- productivity inventors to firms with high implementation intensity, and are responsible for a 32% loss in economic growth. Industrial policies that subsidize R&D spending relax these frictions by boosting inventor productivity, helping high-quality inventors reallocate to firms with high implementation incentives. Under optimal subsidies, growth increases as much as 74 basis points, closing most of the gap in missing growth caused by frictions in the market for inventors.