Lock-In and Productive Innovations: Implications for Firm-to-Firm Innovation Pass-Through

Lucia Casal (Cornell University)

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Abstract:
Firms innovate to improve efficiency and reduce their costs of production (productive innovations) and to increase customer dependency by making products harder to substitute (lock-in innovations). In this paper, I quantitatively study the macroeconomic implications of lock-in innovations for aggregate productivity and market power. I develop a theoretical framework that allows firms to invest in lock-in innovations by reducing product substitutability, while also nesting standard macroeconomic models of productive innovations. A key prediction of the model is that productive innovations by suppliers increase customer firms’ sales by lowering input costs, while lock-in innovations decrease customer firms’ sales by allowing suppliers to charge higher prices for products that are harder to substitute. I use this theoretical insight to identify the nature of innovation in the data and calibrate the model to the U.S. economy. Informed by the observed changes in the response of customer firms’ sales to their suppliers’ innovations, I find that 37% of innovations are lockin, and that their incidence has doubled in recent decades, especially for high markup firms. Moreover, had the incidence of lock-in innovations remained at pre-2000 levels, observed aggregate productivity would have been 3% higher, median markups would have stayed at pre-2000 levels, and markup dispersion would have been 9% lower.

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