Financial Constraints and Innovation
| 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 firms tend to be more productive than domestically owned firms. . . . To the extent that foreign owned firms 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 firm’s decision to invest into innovative and exporting activities is sensitive to financial frictions which can prevent firms 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 amplied effect on firms’ innovation effort and consequently the level of productivity. However, as financial frictions become increasingly severe, these activities become effectively substitutes since both exporting and innovation rely on internal funds of firms.
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.