International R&D spillovers and unobserved common shocks

This paper investigates the effects of the domestic and foreign R&D weighted by bilateral imports on productivity accounting for the heterogeneous impact of unobserved micro and macroeconomic common shocks, which are modeled in a multifactor error structure. Using a panel of 50 economies from 1970-2011, I find that when unobserved common shocks are not regarded, as has been done by the literature in this area, estimates of domestic R&D and foreign R&D might be biased and inconsistent. Once unobserved common shocks are accounted for, by allowing for heterogeneous technology coefficients, significant estimates become more sizable, consistent and not seriously biased in most cases. However, these estimates might be capturing not only returns to domestic R&D and trade-related knowledge spillovers, but also unobserved common spillovers and other effects. This indicates that knowledge spillovers and effects of unknown form cannot be easily separated. Therefore, unobserved common shocks should be considered when estimating returns to domestic R&D and international R&D spillovers.