The production of science

Empirical evidence shows that the average return on R&D spending in scientific research decreases with firm size. I provide an explanation to this fact by developing a model of science production where heterogeneous researchers are endogenously allocated to different firms. The main assumption is that firms invest in research to increase their absorptive capacity: the ability to use and understand scientific findings produced elsewhere. Firms create absorptive capacity by building labs and hiring researchers in a competitive market. Because of externalities, firms underinvest in labs. More interestingly, researchers and labs are substitutes in the revenue function, even though they are complements in the research production function. As a consequence, the greater the investment in science, the lower the productivity of the researcher working for the firm. This generates a novel form of inefficiency: for any given investment, the allocation of researchers to firms is non optimal.