R&D and Productivity: Estimating Production Functions when Productivity is Endogenous

We develop a simple estimator for production functions in the presence of endogenous productivity change that allows us to retrieve productivity and its relationship with R&D at the flrm level. Our dynamic investment model can be viewed as a generalization of the knowledge capital model (Griliches 1979) that has remained a cornerstone of the productivity literature for more than 25 years. We relax the assumptions on the R&D process and examine the impact of the investment in knowledge on the productivity of flrms. We illustrate our approach on an unbalanced panel of more than 1800 Spanish manufacturing flrms in nine industries during the 1990s. Our flndings indicate that the link between R&D and productivity is subject to a high degree of uncertainty, nonlinearity, and heterogeneity across flrms. Abstracting from uncertainty and nonlinearity, as is done in the knowledge capital model, or assuming an exogenous process for productivity, as is done in the recent literature on structural estimation of production functions, overlooks some of its most interesting features.