| Sumario: | This article studies how vertical integration and upstream R&D subsidy affect innovation and welfare in vertically separated industries. I formulate a dynamic structural model of a dominant upstream firm and oligopolistic downstream firms that invest in complementary innovations. I estimate the model using data on the System‐on‐Chip (SoC) and smartphone industries. The results suggest that a vertical merger can increase innovation and welfare, mainly driven by the investment coordination of the merged firms. I also find that subsidizing the upstream innovation increases overall private investment, innovation, and welfare.
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