Fact of the Week: Increasing the Number of Markets a Firm Enters by 10 Percent Boosts Its Share of Employment in R&D by 0.35 Percentage Points

Luke Dascoli January 18, 2022
January 18, 2022

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Source: Chang-Tai Hsieh and Esteban Rossi-Hansberg, “The Industrial Revolution in Services,” U.S. Census Bureau, Center for Economic Studies Discussion Papers, October 2021.

Commentary: Thanks to ICT innovations and new management practices, service-sector firms can more easily scale by establishing multiple businesses in different locations. A recent report from the U.S. Census Bureau’s Center for Economic Studies details the increasing scale in non-manufacturing industries observed since the 1990s as a “new industrial revolution” in services and describes its resulting economic advantages. New ICT such as software allows for more efficient delivery and standardization of services and has little to no variable costs in implementation across establishments, making them especially valuable to firms operating in many markets. Since knowledge produced by research and development (R&D) also has no variable costs in being shared across establishments, multimarket firms are uniquely incentivized to conduct in-house R&D to create new knowledge and ICT innovations.

The Census’s report found that the elasticity between the change in log number of markets per firm and the change in a firm’s share of employment in R&D was 3.65. This elasticity indicates that if a firm grew its number of markets entered by 10 percent, it could anticipate increasing its share of total employment in R&D by 0.35 percentage points. Expanding this elasticity, a firm increasing the number of markets it has entered by 33 percent would enjoy roughly a 1 percentage point increase in its R&D share of employment.

Intuitively, growing firms dedicate a greater effort toward supporting and increasing their growth. But these firms’ greater investments in R&D will drive new innovations to reduce their costs, creating lower prices for consumers and greater positive externalities from a more R&D-intensive private sector.