Capital, Ideas, and the Costs of Financial Frictions

Pablo Ottonello and Thomas Winberry

No 32056, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We study the role of financial frictions in determining the allocation of investment and innovation. Empirically, we find that established firms are investment-intensive when they have low net worth but become innovation-intensive as they accumulate net worth. To interpret these findings, we develop an endogenous growth model with heterogeneous firms and financial frictions. In our model, firms are investment-intensive when they have low net worth because their returns to capital are high. Financial frictions determine the rate at which firms drive down the returns to capital and shift towards innovation. Quantitatively, the aggregate losses due to lower innovation are large, even though the allocation of capital to existing ideas is comparatively efficient. If innovation has positive spillovers, a planner would lower investment among constrained firms to finance more innovation. An innovation subsidy does not generate the correct distribution of investment and innovation to exactly decentralize this outcome.

JEL-codes: E22 E23 G3 O30 O4 (search for similar items in EconPapers)
Date: 2024-01
New Economics Papers: this item is included in nep-cfn, nep-fdg, nep-mac and nep-sbm
Note: CF EFG PR
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