Capabilities and investment in R&D: An analysis on European data

In this paper we test the effect of technological capabilities (accumulated knowledge and organization/production routines) on the R&D intensity for a panel of European industries. Our proxy for capabilities is the distance from the technological frontier. Estimation is carried out with System Generalized Methods of Moments and is robust to various specifications. Our identification strategy is limited to the average (reduced form) effect.We find a strong effect of capabilities on the amount invested in R&D, after controlling for demand pull, technology push, size, and cash constraints. The latter ones are the main variables used in the literature on the determinants of innovative expenditure, of which R&D is one of the components. The elasticity of the distance from the technological frontier is 10%, of similar magnitude (but opposite sign) with regard to the effect of internal resources.When we allow for heterogeneous impact, clustering the industries according to their technological level, we see that the effect of capabilities is robust, but concentrated in Medium and Low Tech sectors. Moreover, the effect is stronger in the upswings of the business cycle and is concentrated in peripheral countries. These latter stylized facts may suggest that the divergence induced by lack of capabilities is somehow nonlinear and increases when a critical mass is missing.