An Economic Theory of Dynamic Capabilities

This article introduces an economic model of dynamic capabilities. The model is intended to bridge the gap between the strategic management literature on dynamic capabilities and the economics literature on the sources of productivity differentials. In the model, dynamic capabilities are an advantage in generating innovations and allow firms to enter new submarkets. We use the model to interpret three types of dynamic capabilities previously identified in the literature: sensing, seizing and transforming. We show that the model has non-trivial predictions for observables that might aid in empirically identifying dynamic capabilities. When firms must invest in order to acquire the dynamic capability to transform, in a dynamic equilibrium, higher levels of innovation may not be associated with possessing the dynamic capability: firms without the dynamic capability can invest more in innovation in order to gain it. This suggests that using innovation investment levels as an intermediate outcome to measure dynamic capabilities may incorrectly identify firms without the dynamic capability as ones with it.