Contact: Prof. Raquel Fernandez - email@example.com
We consider an increasingly utilized class of general equilibrium model in which knowledge diffusion generates positive spillovers across firms. Each period a firm "matches'' with another randomly chosen firm, and can internalize some portion of the matched firm's productivity. Within this class of models, we prove that a small set of parameters characterizing the diffusion process are uniquely identified with exogenous and random variation in matches, and moreover, are independent of the remaining parameter values. We conduct a randomized controlled trial among Kenyan firms in which firms from the left tail of the profit distribution are matched one-to-one with firms from the right tail, then use the empirical results to estimate these parameters. Our quantitative results imply an important role for knowledge diffusion in a series of policy experiments in the model. Optimally subsidizing firm exit to maximize diffusion spillovers increases income by 50 percent relative to a laissez faire policy. Moreover, diffusion benefits can overcome competitive pressure faced by existing firms when new more productive firms are introduced, through either firm entry or training.