Many writers have claimed that research and development (R&D) has two faces. In addition to the conventional role of stimulating innovation, R&D enhances technology transfer (absorptive capacity). We explore this idea empirically using a panel of industries across twelve OECD countries. We find R&D to be statistically and economically important in both technological catch-up and innovation. Human capital also plays an major role in productivity growth, but we only find a small effect of trade. In failing to take account of R&D-based absorptive capacity, existing U.S.-based studies may underestimate the return to R&D.

This paper investigates the relationship between product market competition and innovation. We find strong evidence of an inverted-U relationship using panel data. We develop a model where competition discourages laggard firms from innovating but encourages neck-and-neck firms to innovate. Together with the effect of competition on the equilibrium industry structure, these generate an inverted-U. Two additional predictions of the model-that the average technological distance between leaders and followers increases with competition, and that the inverted-U is steeper when industries are more neck-and-neck-are both supported by the data. © 2005 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.