DP9850 Productivity Spillovers Through Labor Mobility
Do firms have the right incentives to innovate in the presence of productivity spillovers? This paper proposes an explicit model of spillovers through labor flows in a framework with search frictions. Firms can choose to innovate or to imitate by hiring a worker from a firm that has already innovated. We show that if innovation firms can commit to long-term wage contracts with their workers, productivity spillovers are fully internalized. If firms cannot commit to long-term wage contracts, there is too little innovation and too much imitation in equilibrium. Our model is tractable and allows us to analyze welfare effects of various policies in the limited commitment case. We find that subsidizing innovation and taxing imitation improves welfare.Moreover, allowing innovation firms to charge quit fees or rent out workers to imitation firms also improves welfare. By contrast, non-pecuniary measures like covenants not to compete, interpreted as destruction of matches between imitation firms and workers from innovation firms, always reduce welfare.