Financial Constraints and Innovation

17 March 2010 at 12:46 am 2 comments

| Peter Klein |

Why are firms in poor countries less productive than firms in rich countries? Is it lack of technical know-how? Poor infrastructure? Insufficient human capital? Weak intellectual-property protection? Actually, the evidence suggests a more prosaic explanation: financial constraints.

One stylized fact that appears from emerging markets and transition economies . . . is that foreign owned fi rms tend to be more productive than domestically owned firms. . . . To the extent that foreign owned fi rms embody the technological frontier, one can interpret this fact as suggesting that some forces prevent domestically owned firms from emulating the best practices and techniques. . . .

We show that a fi rm’s decision to invest into innovative and exporting activities is sensitive to fi nancial frictions which can prevent fi rms from developing and adopting better technologies. Furthermore, we demonstrate that in a world without financial frictions, innovation and exporting goods are complementary activities. Thus, easing financial frictions can have an ampli ed eff ect on firms’ innovation eff ort and consequently the level of productivity. However, as financial frictions become increasingly severe, these activities become eff ectively substitutes since both exporting and innovation rely on internal funds of fi rms.

That’s from “Financial Constraints and Innovation: Why Poor Countries Don’t Catch Up” by Yuriy Gorodnichenko and Monika Schnitzer. One implication is that diversified firms, whose operating units have access to the firm’s internal capital market, have particular advantages in developing countries, an argument explored in several papers by Khanna and Palepu (e.g., here). In the US, these advantages may not outweigh other drawbacks of unrelated diversification.

Entry filed under: - Klein -, Financial Markets, Innovation, Strategic Management.

Ross Emmett on Innovation Jargon Watch

2 Comments Add your own

  • 1. Robin JG  |  18 March 2010 at 4:24 am

    It’s not just ‘poor’ countries, I seem to recall ample evidence that US firms are more productive here in the UK than our local firms (and no jibes about the state of our economy please).

    Your comment also reminds me, possibly very obliquely, of “The Economic Lives of the Poor” by Abhijit Banerjee and Esther Duflo, where they find that:

    “A pattern seems to emerge. Poor families do seek out economic opportunities, but they tend not to get too specialized. They do some agriculture, but not to the point where it would afford them a full living (for example buying/renting/sharecropping more land).

    This lack of specialization has its costs. Many of these poor households receive most of their earnings from these outside jobs. As short-term migrants, they have little chance of learning their jobs better or ending up in a job that suits their specific talents or being promoted.

    Even the non-agricultural businesses that the poor operate typically require relatively little specific skills. E.g. the businesses in Hyerabad include 11 percent tailors, 8 percent fruit & veg sellers, 17 percent small general stores, 6.6 percent telephone booths, 4.3 percent auto owners, and 6.3 percent milk sellers. Except for tailoring, none of these jobs require high levels of specialized competence that take a long time to acquire and would have higher earnings.

    In several ways, the poor are trading off opportunities to have higher incomes.”

    Whenever I see those photos of queues of women collecting water from a well in small containers, I always wonder why there is no better-organised intermediary to transport the water more efficiently and in volume, freeing up productive time. Your thoughts on this?

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