Globalization and Innovation in Emerging Markets

GLOBALIZATION AND INNOVATION IN EMERGING MARKETS
Yuriy Gorodnichenko Jan Svejnar Katherine Terrell

UC Berkeley University of Michigan University of Michigan
First Draft
September 2007
Abstract
Globalization brings opportunities and pressures for domestic firms in emerging market
economies to innovate and improve their competitive position. Using recent data on firms
in the 27 transition economies, we test for the effects of competition and foreign direct
investment on domestic firms’ efforts to improve the quality of their product through
innovation, taking into account firm heterogeneity. We find support for the prediction
that competition has a negative effect on product and technology innovation and that the
supply chain of multinational enterprises and international trade are important means for
domestic firms to raise their capability (innovate). We do not find support for the
inverted U effect of competition on innovation nor for the hypothesis that the inverted U
relationship holds for firms close to the efficiency frontier, while a negative relationship
prevails for firms far from the frontier. We find partial support for the hypotheses that
firms farther from the frontier are less likely to innovate and that firms in a more pro-
business environment invest more in innovation and are more likely to display the
inverted U relationship between competition and innovation.
Acknowledgements: We would like to thank Xiaoyang Li for valuable research assistance

and the European Bank for Reconstruction and Development for making this research
possible through funding and data availability.
1. Introduction
With the opening of borders to trade and foreign investment, globalization brings
opportunities and pressures for domestic firms in emerging market economies to innovate
and improve their competitive position. Many of these pressures and opportunities
operate through increased competition from and linkages with foreign firms. In this
paper, we use the conceptual frameworks of a recent theoretical model by Sutton (2007)
and a series of models by Acemoglu, Aghion and Zilibotti (2003), Aghion, Bloom,
Blundell, Griffith, and Howitt (2005) – hereafter Aghion et al. (2005a), Aghion, Burgess,
Redding, and Zilibotti (2005) – hereafter Aghion et al. (2005b), and Aghion, Blundell,
Griffith, Howitt, and Prantl (2006) to examine the determinants of innovation by
domestic firms in emerging market economies. Our focus is on the effect of competition
and transfer of capabilities stemming from globalization, which may be brought about
through various channels, including the entry of foreign firms (foreign direct investment
– FDI), trade, and increased competitive responses by domestic firms through both entry
and upgrading of the quality of their products.
Our work also relates to the large literatures on innovation (see e.g., Becheikh,
Landry and Amara, 2006 and Cohen, 2005 for reviews) and FDI spillovers (see e.g.,
Gorg and Greenaway, 2004 for a review). While we focus on testing the theoretical
proposition of the specific models above, we also relate our findings to these broader
literatures.
Overall, our study has found support for the predictions that competition has a
negative effect on product and technology innovation (Schumpeter-Acemoglu-Aghion et
al. effect) and that the supply chain of multinational enterprises and international trade
are important means for domestic firms to raise their capability (Sutton effect). We do not
find support for the inverted U effect of competition on innovation nor for the hypothesis
that the inverted U relationship holds for firms close to the efficiency frontier, while a
negative relationship prevails for firms far from the frontier. We find partial support for
the hypotheses that firms farther from the frontier are less likely to innovate and that
2
firms in a more pro-business environment invest more in innovation and are more likely
to display the inverted U relationship between competition and innovation.
2. Conceptual Framework and Review of Related Empirical Literature

Sutton (2007) develops an industrial organization model capturing the effect of
globalization on the behavior of firms in the emerging market economies. The model
assumes that a firm’s competitiveness depends not only on its productivity but also on the
quality of its product, with productivity and quality jointly determining a firm’s
“capability.” In particular, Sutton’s (2007) model has the property that consumers choose
to buy on the basis of price-quality combinations and if a firm has a product whose
quality is superior to that of its rivals, the firm will retain some level of market share even
when the number of low quality rivals becomes arbitrarily large. Moreover, there is a
lower bound on quality that any firm has to maintain in order to survive, thus creating a
range (“window”) of quality levels in which firms can operate. What matters is relative
quality at both the firm and country levels, and with globalization the lower bound on the
window of opportunity rises for firms that were previously shielded from the competition
by higher quality firms in advanced economies.
An important prediction of the Sutton (2007) model is that after an initial
shakeout, firms in emerging markets will strive to adjust by raising their capabilities.
Sutton (2007) suggests that the process will vary widely across industries and stresses
that it will be influenced by the vertical transfer of capabilities to the emerging market
economies through the supply chain of multinational enterprises (MNEs). In fact, he
argues that “…the ‘middle group’ countries of Eastern Europe… are best placed to be the
most dramatic beneficiaries of the present globalisation, not – or not primarily – because
of trade liberalization per se, but because of the virtuous dynamic that follows as part of
the general package of liberalization of foreign direct investment and capability transfer”
(Sutton, 2007, p. 28). Given these predictions, we examine the factors that determine the
extent to which different types of firms raise their capabilities. In line with Sutton’s
3
conceptual framework, we look at factors that may influence capability at the firm,
industry and country or regional levels.
A related theoretical framework has been advanced in a series of recent papers by
Acemoglu et al. (2003), Aghion et al. (2005a), Aghion et al. (2005b), and Aghion et al.
(2006). In these Schumpeterian models firms or industries operate within a range
(window) of efficiency and increased competition associated with liberalization and
globalization has different effects on firms/industries that are close to the frontier
(maximum efficiency) than those that are far from the frontier (near the lower bound). In
particular, firms/industries close to the frontier are expected to be spurred by competition
and increase their efficiency, while those far from the frontier are expected to be
discouraged from innovating and fall further behind. The model also predicts that firms
located in regions with more pro-business institutions are more likely to respond to the
threat of entry (competition) by investing in new technologies and production processes.
Aghion et al. (2005a) develop an even sharper theoretical prediction, proposed
earlier by Kamien and Schwartz (1972), namely that the effect of the intensity of
competition on the extent of innovation is in the form of an inverted U, implying that too
little and too much competition has a more negative (less positive) effect than an
intermediate amount. In the Aghion et al. (2005a) model this prediction is driven by the
combination of the aforementioned differential effect of competition on the laggards and
leaders, and the effect of competition on equilibrium industry structure. A related
prediction of the model is that the inverted U is steeper in sectors where incumbent firms
operate at similar technological levels (neck-and-neck sectors), while a negative
(Schumpeterian) effect of competition on innovation should dominate in sectors where
innovations are made by laggard firms with low initial profits.
The predictions of the Sutton model have yet to be tested empirically, whereas.the
predictions of the Acemoglu et al. (2003), and Aghion et al. (2005a, 2005b and 2006)
models have been tested in a few studies and the tests have yielded mostly but not
4
completely supporting evidence. In this section, we briefly review these tests and existing
evidence in order to place our results in a comparative perspective.
Using an unbalanced panel of 311 firms listed on the London Stock Exchange
between 1973 and 1994, Aghion et al. (2005a) construct a two-digit SIC industry panel of
354 industry-year observations. Using price cost margin (markup) as the competition
indicator and citation-weighted patents as a measure of innovation, the authors find an
inverted U effect of competition on innovation.
Aghion et al. (2005b) analyze a three-digit state-industry data from India for the
period 1980-97 to find that entry liberalization (de-licensing) increased within-industry
inequality in output, labor productivity and total factor productivity.
Aghion et al. (2006) combine a variety of US and UK data sources to create a
1987-93 annual panel data set of over 23,000 establishments in 180 4-digit manufacturing
industries and a data set of patents in over 1,000 incumbent UK firms. They find that
technologically advanced entry by foreign firms has a positive effect on innovation in
sectors initially close to the frontier and that the effect of entry on total factor
productivity growth interacts negatively with the distance to frontier.
Using 1992-2000 annual panels of Russian and Czech data on the population of
industrial firms in the two economies, Sabirianova, Svejnar and Terrell (2005a,b) find
support for the distance from the frontier hypothesis on the part of the foreign-owned but
not domestically-owned firms in the host countries. In particular, greater entry by foreign
firms in a given industry has a positive effect on the productivity of foreign firms but a
negative effect on the productivity of domestic firms. Moreover, the authors assign each
firm in each year to the bottom third, middle third and top third of the overall efficiency
distribution on the basis of the firm’s estimated productive efficiency and within each
ownership category they calculate the average annual probability that a firm in a given
efficiency group moves to one of the other two efficiency groups, stays in the same group,
or exits during the 1992-2000 period. They find that the proximity to the frontier
hypothesis is supported by the behavior of foreign firms in Russia and (somewhat less so)
5
in the Czech Republic, but that it is contradicted by the behavior of both private and
state-owned domestic firms. These findings suggest that Sutton’s prediction that the
effects may vary across industries and other dimensions (e.g., firm ownership and
governance) may have validity.
Finally, Aghion, Carlin and Schaeffer (2002) use the 1999 Business Environment
and Enterprise Performance Survey (BEEPs) to examine the effect of competition on new
product restructuring (innovation), sales and soft budget constraint. Their equation related
to new product restructuring suggests that (a) new firms (those established after 1990)
innovate more than the old ones (those established under communism), (b) firms with
hard budget constraints innovate more than those with soft budget constraints, (c)
competitive pressure by foreign firms induces innovation by both old and new firms but
more so by the old ones, (d) competitive pressure by domestic firms does not boost
innovation by either type of firms. These finding lead us to examine the effect of
competition on innovation with 2002 and 2005 BEEPS data in greater depth and breadth.
Recognizing that the extent of innovation varies across types of firms, industries
and countries, we test the following predictions derived in the literature:
1. Globalization stimulates innovation by domestic firms through the supply chain of
MNEs (transfer of capabilities);

2. Firms close to the frontier are spurred to innovate, while those further away are
discouraged from innovating;
3. Globalization increases competition, whose effect on innovation is complex:
a. In general the effect of competition on innovation is hypothesized to have
an inverted U shape;
b. The inverted U is steeper in sectors where firms operate at similar
technological levels (neck-and-neck);
c. A negative relationship between competition and innovation dominates in
sectors where innovations are made by laggard firms (those further from
the efficiency frontier);
6
d. Firms located in more pro-business environment respond to competition
by investing in new technologies and other innovations.
3. Data and Econometric Specification

To test these predictions, we use data from the 2002 and 2005 Business
Environment and Enterprise Performance Survey (BEEPS), a joint initiative of the
European Bank for Reconstruction and Development (EBRD) and the World Bank Group.
These are large surveys of enterprises (6,500 in 2002 and 7,900 in 2005) in 27 transition
countries (including Turkey) 1 which relied on very similar sampling frames and
questionnaires. In each country, the sectoral composition of the sample in terms of
manufacturing2 versus services3 was to be determined by their relative contribution to
GDP. Firms that operate in sectors subject to government price regulation and prudential
supervision, such as banking, electric power, rail transport, and water and waste water,
were excluded from the sample. The sample includes very small firms with as few as
two employees as well as firms with up to 10,000 employees. Moreover, the data include
firms in the rural areas as well large cities. Hence these data enable us to analyze quite
heterogeneous firms in these countries, and perhaps most important is the inclusion of
firms in the service sector, which is the new dynamic sector in these economies.
In addition, the data set contains a panel component, where 1,443 firms that were
surveyed in 2002 were surveyed again in 2005. We use this panel data set for an
important robustness check. However, our analysis relies primarily on the pooled 2002
and 2005 data since many variables of interest have a retrospective component and
because it is hard to detect robust relationships with the relatively small panel sample,
especially when we use many control variables.
1
Both were to be administered to 28 transition economies: 16 from CEEE (Albania, Bosnia and
Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Former Yugoslavia, Hungary, Latvia, Lithuania,
Poland, Romania, Slovak Republic, Slovenia and Turkey) and 12 from the CIS (Armenia, Azerbaijan,
Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine and
Uzbekistan). In neither year could the survey be administered in Turkmenistan.
2
Manufacturing includes mining and quarrying, construction, manufacturing and agro-processing.
3
Services includes: Transportation, storage and communications; wholesale, retail, repairs; real estate,
business services; hotels and restaurants; other community, social and personal activities; and commerce.
7
An important advantage of our data is that firms self-report various types of
innovation activity. Most studies on innovation use patent data or R&D expenditures.
Studies using patents are generally viewed as having two problems. First, patents
measure inventions rather than innovations. Second, tendency to patent varies across
countries, industries and processes, and firms often prefer to protect their innovations by
other appropriability methods such as technological complexity, industrial secrecy, and
maintaining lead time over competitors. Using R&D expenditures may also be
problematic because not all innovations are generated by R&D expenditures, R&D does
not necessarily lead to innovation, and formal R&D measures are biased against small
firms (Michie, 1998; Archibugi and Sirilli, 2001). Moreover, in emerging market
economies these types of innovations are less likely to be observed as firms are expected
to engage more in imitation and adaptation of already created and tested innovations,
rather than in generating new inventions.
In this study, we define innovation broadly as the development of new products,
adoption of new technologies or obtaining of licenses and quality certifications. Within
product innovation we consider ‘major new product lines’ as well as ‘upgrading an
existing product line.’ In the BEEPS survey, firms are asked whether or not they have
undertaken any of the following initiatives in the last three years:

• Developed successfully a major new product line or upgraded an existing
product line – hereafter New Product;
• Acquired new production technology -- hereafter New Technology;
• Obtained a new product licensing agreement or a new quality accreditation
(such as ISO 9000, 9002 or 14000, AGCCP, etc.) -- hereafter New License.
Given the nature of the questions, our dependent variables New Product, New Technology
and New License, respectively, are dummy variables.
The BEEPS data also permit us to capture in three different and complementary
ways the degree of competition faced by each firm. A key variable that is comparable
with that used by Aghion et al. (2005a), as well as Nickell (1996), is the price-cost
8
margin or markup (Markup). Firms that are able to charge a larger markup are deemed to
have less competition. The advantage of this indicator over a market share or Herfindahl
index is that it does not require precise definition of geographic and product markets,
which is difficult to obtain in emerging market economies that vary considerably by size
and geographic reach of firms. We are also able to capture the Elasticity of Demand of a
firm through dummy variables for completely inelastic, low elasticity, and medium-high
elasticity. Finally, we can estimate the effect of Pressure from Foreign Competition with
three dummy variables for low, and medium-high, with “not important” as the base
response. (For more detail, see the description of variables in Table A1.)
BEEPS also permits us to capture in various ways the extent to which there may
be a vertical transfer of capabilities from foreign firms. We use three variables: SMNE,
the share of a firm’s sales to MNEs;4 Exports, share of sales exported; and Imports, share
of inputs imported.
To test whether firms that are further away from the efficiency frontier innovate
less than firms that are closer to the frontier, we define the frontier and then calculate
each firm’s distance from the frontier. In view of the substantial evidence that foreign
firms are more efficient than domestic ones, especially in developing countries (e.g.,
Sabirianova, Svejnar and Terrell, 2005a), we assume that the best (the most efficient one-
third of) foreign firms embody the efficiency frontier. We draw on the literature on
matching (e.g., Rosembaum, 2002) and measure the distance of a domestically-owned
firm to the leading foreign-owned firms in an industry and country with the Mahalanobis
distance, which assumes that firms that are similar in a set of observed characteristics are
likely to have similar efficiency. Conversely, if the observed characteristics of domestic
firms are different from those of the best foreign-owned firms, the domestic firms are
likely to be less efficient than the best foreign-owned firms. One may hence interpret this
difference as the distance from the best business practice of foreign-owned firms. The
Mahalanobis distance of domestic firm i to a foreign firm is equal to:

4
MNEs is defined here as a firm with 50% or more foreign ownership.
9
distancei = min{( xiD − x Fj )′S x−1 ( xiD − x Fj )}1/ 2
j∈F
Where superscripts F and D denote the best foreign-owned firms and domestic
companies, respectively, and Sx is the covariance matrix of the vector of observed

characteristics x. This amounts to computing the distance of a given domestic firm to all
foreign firms that embody the frontier and taking the minimum distance. In other words,
we take the distance to the nearest relevant foreign firm. The vector of observed
characteristics contains the size of the firm in terms of the logarithm of number of
employees and number of establishments; the structure of employment (educational
attainment, share with, vocational school, secondary school, college; skill level: share of
managers, share of professional workers; share of permanent workers), capacity
utilization in terms of machinery and labor, markup, share owned by largest
shareholder(s); growth rates (of sales and capital); a dummy for paying for security. We
match firms exactly by industry, country and year, i.e., domestic firms are matched only
to foreign-owned firms in the same industry, country and year. Since the distance is
skewed, we take log(1 + distance) as the distance from the frontier in our specification.
The larger the Mahalanobis distance, the further the domestic firm is from the best
foreign firms in its industry/country.
We estimate the following baseline specification with the pooled data in the 2002
and 2005 BEEPS for domestically owned firms:
I isct = Φ {α0 Markupisct + α1DEisct + α 2 ForCompisct +

β 0 SMNEisct + β1Exportisct + β 2 Importisct + δ1 ln(1 + distanceisct ) +
(1)
γ 0 ln Lisc,t −3 + γ 1 (ln Lisc ,t −3 )2 + γ 2 ln CU isc ,t −3 + γ 3 EDU isc ,t −3 + γ 4 SKILLisc ,t −3 +
γ 5 Ageisct + γ 6CNM + γ 7 R & Disct + γ 8 SOEisct + ωsct + error}
where I is the dummy variable equal to one if firm reported an innovation and zero
otherwise; Φ denotes c.d.f. of a standard normal random variable; i, s, c and t index
firms, sector, country and time. Variables dated with period t-3 are taken from
retrospective questions about the firm’s performance three years prior to the current date.
The set of variables in the first set of parentheses capture our three measures of
10
competition: Markup, DE -- the elasticity of demand and ForComp -- pressure from
foreign competition. The next set of explanatory variables captures vertical linkages or
transfer of capabilities: SMNE -- the share of sales to multinational enterprises, Export --
the share of export in sales and Import -- the share of imported imports.5 The variable
distance is the Mahalanobis distance and ω is a set of controls for industry, country and
time fixed effect. The last set of variables control for a number of firm-specific factors
deemed to be important in the literature:
L (the number of employees) and L2 measure the size of firm, which has been
found to be positively correlated with innovation. The argument for including size is that
large companies have more resources to innovate and can benefit from economies of
scale in R&D production and marketing;6
CU -- Capacity Utilization -- is the percentage of a firm’s output relative to
maximum possible output. Although capacity utilization has been found to be a strong
predictor of innovations (e.g., Becheikh et al 2006), the effect of CU on innovation is a
priori indeterminate. If firms are too busy filling demand, they may be more interested in
extending their current capacity than finding new ways of producing goods and services.
At the same time, if firms are at capacity they may need to innovate;
EDU (the share of workers with a university education) and SKILL (the share of
skilled workers) capture Human Capital in the firm. These variables might be expected
to be positively correlated with innovation if EDU reflects the involvement of workers in
R&D and more skilled workers (SKILL) are able to give feedback to the firm on how to
improve a product;
Age -- Age of the firm in number of years since the firm began operations in the
country), where two hypotheses are plausible – one suggesting that older firms developed
routines that are resistant to innovation and another suggesting that older firms will
5
Note that in contrast to previous literature we have firm-level variables describing linkages instead of
industry-level variables (e.g., Bertschek 1995).
6
This variable is probably one of the most studied firm characteristics determining innovation.
11
accumulate the knowledge necessary to innovate – few studies have analyzed this firm
characteristic and there is evidence for both hypotheses;
CNM is a dummy equal to one if the firm competes in the national markets and
zero otherwise. We expect CNM to have a positive effect on innovation, given that the
firm operates in a larger market.
R&D is a dummy variable equal to one if the firm has positive expenditures on
research and development and zero otherwise. We have noted that much of the research
proxies innovation with R&D expenditures. However because we believe that using
R&D expenditures can be problematic because not all innovations are due to R&D
expenditures, R&D does not necessarily lead to innovation, and R&D biases against
small firms, we do not use this as a dependent variable, but rather include it as a control
variable that captures the extent to which R&D investment leads to innovation.
SOE - State Owned Enterprise – is a dummy variable equal to one if the
government owns 50% or more of the firm and zero otherwise. This variable is expected
to be negatively correlated with innovation for a variety of reasons, including a poor
system of rewards for innovative activities in state-owned enterprises (SOEs);
We report in Table A1 a detailed description of the variables and in Table A2 –
their means and standard deviations for the whole sample of domestically owned firms,
as well as for some stratifications of the sample that we use in our analysis. Domestically
owned firms are defined as firms with zero share of foreign ownership.
4. Findings
4.1 Baseline Specification
Our baseline specification for each of the three types of innovation, estimated
with over 11,500 firm-level observations in the 27 countries, is reported in Table 1.
Two of our three measures of competition, markup and elasticity of demand, have
a negative effect on innovation as proxied by new product and new technology. In
particular, the larger is the markup (implying less competition), the greater the probability
12
that the firm develops a new product and acquires new technology. Similarly the more
elastic the firm’s product demand, the less likely the firm is to carry out innovation in
these two areas. Markup and demand elasticity do not have an effect on the third
dimension of innovation that we measure, namely obtaining a new license. The finding
that firms with less competition are more likely to innovate vis a vis their product and
technology implies that monopolists or firms with a larger market share will innovate
more, a finding in several empirical studies (e.g., Blundell, Griffith and Van Reenen,
1999). There are various interpretations as to why this relationship is found. Some argue
that monopolist have deeper pockets.
Interestingly, we do not find the inverted U shaped relationship between
competition and innovation proposed by Kamien and Schwartz (1972) and developed
more recently by Aghion et al. (2005). When we estimate a specification that includes
markup and markup squared, the two coefficients are statistically insignificant. Moreover,
as may be seen in Table 1, the coefficient on low elasticity of demand is not significantly
different from the base (completely inelastic demand) within each type of innovation and
the coefficient on medium and high elasticities is negative and significant for two types
of innovation and almost significant for the third one, implying a declining rather than an
inverted U shape relationship. 7 Our baseline specification hence supports the basic
Schumpeterian view that monopolistic market structures boost innovative activity.
Unlike markup and demand elasticity, greater pressure from foreign competition
has a positive effect on innovation. Firms feeling that pressure from foreign competition
is fairly and very important in reducing their production costs innovate more in all three
areas than firms that feel this pressure is “not at all important.” Firms that feel that the
pressure is slightly important in turn have coefficient estimates that fall between. These
results suggest that foreign and domestic competition have different effects on innovation.
7
We also estimated a specification where separate coefficients were estimated for medium and high
elasticities of demand and found that while the high elasticity coefficient was generally more negative than
the coefficient on medium elasticity, they were usually not significantly different from each other. In order
to be more parsimonious, we combined the medium and high elasticity variables into one.
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Greater foreign competition stimulates innovation while domestic competition, proxied
by markup and demand elasticity while controlling for foreign competition, stifles it. This
is an intriguing finding that ought to be explored further in the design of future surveys.
Vertical transfer of capability from foreign to domestic firms, stressed by Sutton
(2007), are significant. As may be seen in Table 1, firms that have stronger vertical
relationships with multinationals, either domestically (by supplying them) or out of the
country (by exporting or importing), innovate more than firms that have weaker links. A
one percentage point increase in the domestic firm’s share of sales to MNEs or exports or
share of inputs imported has a very similar impact on all three types of innovations.
Vertical transfers of capability thus appear to be strong for all three types of innovation.
Using Mahalanobis distance we find mild support (at the 10% significance test
level) for the Aghion et al. (2003, 2005) hypothesis that firms that are further away from
the frontier are less likely to innovate in terms of developing a new product or acquiring
new technology. As with the markup and demand elasticity, the distance is not
significantly related to obtaining a new license. Hence, the empirical support for the
distance to the frontier prediction is mild and limited to product and technology
innovations.
There are a number of interesting findings with respect to the control variables in
reported in Table 1. First, larger firms tend to innovate more than smaller firms, which is
consistent with the finding in the vast majority of the studies on innovation (see e.g.,
Becheikh, Landry, and Amara, 2006). The size effect is linear (and with very similar
coefficients) for new product and new technology, but for new license it is increasing at a
decreasing rate. Second, firms with higher capacity utilization are less likely to innovate
than firms that have more unutilized capacity. This may imply that firms that are selling
everything they produce feel less need or have less time to innovate than firms that have
more down time because of low demand. The negative effect is highly significant across
all three types of innovation and it is the strongest for developing a new product. Third,
firms with positive expenditures on R&D are more likely to innovate than firms that
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spend nothing on R&D. The coefficients are highly significant and a bit higher for
developing a new product and obtaining new license than for acquiring new technology.
This suggests that the acquisition of new technology contains a somewhat greater element
of purchase than own development through R&D in comparison to the other two
innovations. Fourth, the effect of human capital varies across the three types of
innovation. Having a higher share of skilled workers does not affect the probability of
developing a new product or acquiring new technology, but has a negative effect on the
probability of obtaining a new license. On the other hand, as the share of workers with a
university education rises, innovation is boosted across all three types. Hence having a
higher share of labor force with university education is more conducive to innovation
than having a higher share of skilled labor. This result is consistent with the hypothesis
that more educated labor force has a greater capacity to absorb and develop new products,
technologies and licenses. Fifth, older firms are not as likely to innovate with respect to
product and technology but have the same probability of obtaining a new license as new
firms. Sixth, state-owned (50% or more) firms are less likely to innovate than privately
owned firms. The state-private gap is largest in the creation of new products. Finally,
firms that compete/operate in national markets are about 20 to 25% more likely to
innovate in any of the three areas than firms that only compete/operate in a local or
regional market. This may reflect both the capability of the firms operating at the
national level as well as the characteristics of the national as opposed to local
environment.
4.2 Robustness Checks
We have carried out two robustness checks: one of our Mahalanobis measure of
the distance to the frontier and another for the potential endogeneity of our firm-level
measures of competition, transfer of capabilities and distance to the frontier.
a) Distance. To test the robustness of the Mahalanobis distance measure, we re-
estimate the baseline equation with a measure that captures differences in efficiency
15
using the Solow residual or total factor productivity (TFP). We compute the Solow
residual with the cost share for labor and capital (computed for each firm and aggregated
for a given industry in each country and year) and adjust it for capacity utilization:
Solowijt = TFPijt = ln Yijt − s jL ln Lijt − (1 − s jL ) ln K ijt − ln CU ijt ,
where i, j, c, and t index firms, industries, countries and time. We then estimate the Solow
distance measure as the log of the ratio of the TFP of the most efficient foreign firm in a
given industry and country to the TFP of each domestic firm in the same industry and
country.
Using the Solow measure is problematic in our data since only about one-half of
the firms report sales revenue. With only 5,548 firm observations, we find in appendix
Table A3 that the coefficients on Solow distance measure are similar to those of the
Mahalanobis distance in suggesting that there is a negative and significant relationship
between distance and innovation. Hence, our results are robust to alternative measures of
the distance from the frontier. Because we lose so many observations with the Solow
distance measure, we continue to use the Mahalanobis distance in the rest of the paper.
b) Endogeneity. Because our variables for competition, vertical transfer of
capabilities and distance are reported in the years of the survey (2002 and 2005), while
innovation is measured over the preceding three-year periods (1999-2002 and 2002-2005,
respectively), there is a potential problem that the causality runs from the dependent
variable to the explanatory variables (i.e., that the regressors are endogenous). For
example, while it may be that firms with larger markups or those selling more to MNEs
tend to innovate, it is also possible that firms that have innovated are more able to
generate a larger markup or sell more to MNEs than firms that have not innovated. We
address this potential problem in three ways.
First we note that the potential endogeneity problem of these variables does not
affect the other coefficients because estimating the regression without these variables
16
does not lead to a tangible change in the coefficients or standard errors on the other
variables of interest.
Second, the reverse causality is less of a problem if the values of the explanatory
variables in question (the firm’s competition, sales to MNEs, export, import, competition,
and markup) do not vary much over a given three-year period. Within the subsample of
about 1,000 BEEPs firms for which we could link the 2002 and 2005 survey data and
hence create a panel, the correlation coefficients between the 2002 and 2005 values of
Exports, Imports and SalesMNEs, respectively, are relatively high -- 0.95, 0.93 and 0.42.
The competition variables are dummy variables and the probability of reporting the same
value (staying in the same group) is around 50%. The only variable that has a relatively
low correlation between 2002 and 2005 values is markup (0.2). All but one of these
coefficients hence show considerable persistence, especially when one considers that a
number of the variables are expressed as shares.
Third, we replicate our estimates on the panel subsample of BEEPs firms, which
allows us to regress the innovation variables, measured for the period 2002-05 on the
2002 values of firm’s competition, vertical transfers, and distance from the frontier. By
construction, these “initial value” regressions eliminate the possibility that the
relationship between a firm’s innovation and competition, vertical transfers, and distance
from the frontier is brought about by contemporaneous shocks to these variables. Because
the panel subsample is much smaller than the entire sample, we use a use a more
parsimonious specification and check whether and how our findings are affected by this
simplification. In particular, we include only the country and industry fixed effects as
control variables. Moreover, because in the panel data there is a degree of
multicolinearity among the various competition variables, we include them one at a time.
Finally, because of the small sample size and the fact that the majority of the non-zero
values in the share of sales to MNEs, share of exports and share of imports variables are
close to unity (greater than 90%), we convert these variables from shares into dummy
variables.
17
In order to check what drives the difference, if any, between the estimates from
the full sample and panel data, we estimate the more parsimonious specification for (a)
the full sample, using pooled 2002 and 2005 data and current 2002 and 2005 values of
the explanatory variables, as in the base specification; (b) the pooled 2002 and 2005 data
on the panel of firms, using current 2002 and 2005 values of the explanatory variables;
(c) only the 2005 data on the panel of firms, using current 2005 values of the explanatory
variables; and (d) only the 2005 data on the panel of firms, using 2002 (i.e., three year
lagged) values of the explanatory variables. The model in (a) reveals whether the more
parsimonious specification applied to the full sample yields similar results to those in the
base specification reported in Table 1. It also provides a benchmark against which to
compare the estimates from the panel subsample. The estimation in (b) is identical to that
in (a) except that it uses the panel subsample of firms. Comparing the estimates in (b) to
those in (a) hence permits us to assess whether for the purposes of our study the panel is a
representative subsample of the full sample. The estimation in (c) is identical to (b) but
uses only the 2005 part (i.e., the more recent half) of the panel. Comparing the estimates
in (c) to those from (b) permits us to infer how much significance, if any, we lose by
using just the more recent half of the panel data observations. Finally, the results in (d)
represent the ideal specification, which explains innovation over the 2002-05 period with
the lagged (2002) values of the explanatory variables (using the 2005 part of the panel for
the dependent variable with the values of the variables in the 2002 part for the
independent variable). Comparing the results in (c) and (d) enables us to assess the
difference in the estimated coefficients between the specification using the current v. the
lagged values of the explanatory variables. The coefficients from each of these four
specifications are presented in appendix Tables A4.1 for the competition variables and
Table A4.2 for the transfer of capability and distance variables.
Taking the effect of competition first, the coefficients in columns (a) of Table
A4.1 indicate that applying the more parsimonious model to the full sample yields similar
coefficient signs and significance on markup, medium and high elasticity of demand and
18
medium and high pressure from foreign competition as the base model in Table 1. In two
of the three cases it also yields more significant coefficients on the low elasticity of
demand and in two of the three cases it yields more significant coefficients on low
pressure from foreign competition. In terms of our hypotheses, the more parsimonious
specification hence does not greatly affect our findings except that it suggests that there
may be an inverted U relationship between competition and innovation in terms of new
product and new technology. This implies that empirical support for the inverted U
hypothesis of Kamien and Schwartz (1972) and Aghion et al. (2005a) may be sensitive to
the inclusion of control variables beyond country and industry fixed effects and it hence
raises the question of whether the U shaped relationship found in some of the other
studies might be brought about by omitted variables.
A comparison of the results in columns (a) and (b) in Table A4.1 indicates that
going from over 11,500 observations in the full pooled sample to about 2,000
observations in the pooled panel data maintains the signs and in most instances also the
significance of the key coefficients. The only change in signs occurs for the coefficients
on markup for new technology and on medium and high elasticity of demand for new
license, but the change of sign is immaterial since both of these coefficients are
statistically insignificant.
Comparing columns (b) and (c) in Table A4.1 demonstrates that going from the
2,000 pooled panel observations for 2002 and 2005 to just 1,000 observations for 2005
maintains all signs and reduces the significance of just three coefficients. Finally, using
the lagged (2002) rather than the current (2005) values of the explanatory variables with
the 2005 panel observations, i.e., moving from columns (c) to (d) in Table A4.1, reduces
the significance on four and increases the significance on two of the fifteen coefficients.
Interestingly, in the two cases where the coefficient becomes significant (medium and
high pressure from foreign competition for new product and markup for new technology)
it also becomes similar to the corresponding coefficient in the full sample estimates in
column (a) of Table A4.1 and the corresponding coefficient in the base model in Table 1.
19
Moreover, in two of the four cases where the coefficients switch from being significant to
insignificant, the point estimates shift to being quite similar to the full sample coefficient
in Table A4.1 and Table 1. The results hence suggest that using the large pooled sample
of 2002 and 2005 data with the current values of the competition variables does not
generate major biases in the estimated coefficients.
Turning to the transfer of capability and distance from the frontier, we observe in
columns (a) of Table A4.2 that applying the more parsimonious model to the full sample
yields the same signs on all the coefficients as those in the base model in Table 1. All the
coefficients are statistically significant, thus generating the same degree of significance
on the transfer of capability variables (sales to MNEs, export share and import share) and
more uniform significance on the Mahalanobis and Solow distance variables than the
base model in Table 1. In terms of our hypotheses, the more parsimonious specification
hence does not greatly affect our qualitative findings except that it indicates that the
strength of the empirical support for the distance hypothesis depends somewhat on the
inclusion of control variables beyond country and industry fixed effects.
A comparison of the results in columns (a) and (b) in Table A4.2 indicates that
going from over 11,600 observations in the full pooled sample to about 2,000
observations in the pooled panel data maintains the signs and in most instances also the
significance of the key coefficients. There is no loss of significance on transfer of
capability variables and the reduction in significance occurs in the coefficients on
Mahalanobis and Solow distance for new technology and Mahalanobis distance for new
license. Interestingly, with these shifts the panel data estimates approximate the base
model estimates in Table 1 and Table A3 better than do the estimates in columns (a) of
Table A4.2.
Just as with competition, comparing columns (b) and (c) in Table A4.2
demonstrates that going from the 2,000 pooled panel observations for 2002 and 2005 to
just 1,000 observations for 2005 maintains all but one sign and reduces the significance
of just three of the fifteen coefficients. The change of sign is inconsequential since both
20
coefficients are statistically insignificant and the loss of significance on the three
coefficients is smaller than appears at first sight since one of the coefficients that lose
significance is close to being significant at the 10% test level.
Finally, moving from columns (c) to (d) in Table A4.2 (i.e., going from the
current (2005) to lagged (2002) values of the explanatory variables), reduces the
significance on two coefficients (import in the case of new technology and new license)
and generates significance on two coefficients (sales to MNEs in the case of new product
and new technology). As with the competition results in Table A4.1, in the two cases
where the coefficient becomes significant it also becomes more similar to the
corresponding coefficient in the full sample estimates in column (a) of Table A4.1 and in
the base model in Table 1. Moreover, in two of the four cases where the coefficients
switch from being significant to insignificant, the point estimates shift to being quite
similar to the full sample coefficients in Table A4.1 and Table 1.
Overall, the results in Tables A4.1 and A4.2 suggest that using the large pooled
sample of 2002 and 2005 data with the current values of the competition, transfer of
capability and distance variables is a reasonable empirical strategy that does not generate
major biases in the estimated coefficients.
4.3 Distance to the Frontier and the Effect of Competition and Transfer of Capability
In this section we provide further tests of the prediction that the effect of
competition and vertical transfer of capabilities differs between firms that are closer to
and further from the frontier. In order to do so, we estimate the baseline specification
separately for three groups of firms, according to where they lie in the distribution of the
Mahalanobis distance to the frontier. The key hypotheses in the Aghion et al. (2005a,
2006) models are that (a) firms closer to the frontier are spurred by competition to
innovate, while those far from the frontier are discouraged from innovating, (b) the
inverted U relationship between competition and innovation is more likely to be found
21
and be steeper among firms that are closer to the frontier, while a negative relationship is
likely to be found in firms that are further from the technological frontier.
Examining the coefficients on the competition variables in the columns titled
“close” (to the frontier), middle and “far” (from the frontier) in Table 2, we find
relatively little support for these hypotheses. The strongest element of support is found in
only one of the three types of innovation: new product. The coefficients on Markup
suggest that product innovation in firms near the frontier is not significantly related to
competition, while product innovation in firms further from the frontier is negatively
related to competition (positively related to markup). Hence, these results do not support
the prediction that firms near the frontier will be spurred by competition to innovate, but
they support the prediction that firms further from the frontier will be discouraged by
competition from innovating. The estimated coefficients on Markup are positive for all
three types of firms with respect to new technology innovation and the coefficient is in
fact largest for firms close to the frontier, suggesting that greater competition discourages
all firms from innovating and the effect is especially strong for firms near rather than far
from the frontier. Finally, competition as measured by Markup has no detectable effect
on innovation of any type of firms in terms of obtaining a new license.
The estimated coefficients on the Elasticity of Demand variables provide evidence
against the inverted U hypothesis for firms that are close as compared to those that are far
from the frontier. For new product innovation one observes the strongest counter
evidence in that firms far from the frontier display an inverted U pattern, while those near
the frontier display a negative Schumpeterian relationship between the strength of
competition and innovation. With respect to new technology, all three types of firms
register a negative Schumpeterian relationship, and there is no relationship between
competition and innovation for any of the three types of firms for new license.
Finally, all three types of firms increase all three types of innovation with greater
pressure from foreign competition and one cannot reject the hypothesis that within each
22
class of innovation the corresponding coefficients are the same for the three types of
firms.
The competition results in Table 2 hence extend the baseline findings in Table 1
by showing that (i) greater foreign competition stimulates all three types of innovation
irrespective of the distance of the firms from the frontier (ii) greater competition (while
controlling for foreign competition) stifles product and technology innovation in firms
that are close as well as far from the frontier and is unrelated to new license innovation
irrespective of the firm’s distance to the frontier. Each of these results also holds when
we enter just one measure of competition at a time.
The key hypothesis with respect to the relationship between vertical transfer of
capabilities and innovation is that firms closer to the frontier are in a better position than
firms farther from the frontier to imitate the technology of foreign firms. As may be seen
from Table 2, we do not find support for this hypothesis in any of our three vertical
transfer variables. Virtually all the coefficients are highly significant and one cannot
reject the hypothesis that the effects are the same for firms that are close and far from the
efficiency frontier. Hence, Sutton’s (2007) prediction that the vertical transfer of
capability is an important phenomenon is strongly supported, but the effect seems to be
strong across the board irrespective of the relative efficiency of domestic firms.
4.4 Heterogeneity Across Sectors and Age of Firms
One of the key predictions advanced by Sutton (2007), which is also implicit in
the other models, is that the effects of globalization may vary across different sectors of
the economy. We therefore test whether the effects of competition and vertical linkages
with foreign firms on innovation are different for firms that are in manufacturing than
those in services and for firms that were established during communism vs. new ones
created during the transition to a market economy. This manufacturing-service sector
distinction is useful because the service sector is rapidly gaining in importance in many
23
emerging market economies and existing studies of FDI and innovation have invariably
used data on manufacturing rather than services.
The estimates in Table 3 indicate that there is not much heterogeneity in the
innovation effect of competition, vertical transfer of capabilities and distance to the
frontier between firms in manufacturing and services. The coefficients are for the most
part similar and in only one instance (demand elasticity for new license) can one reject
the hypothesis that the coefficients for manufacturing and service sectors are equal. The
results hence indicate that the effect of globalization, as captured by our three sets of
variables, is broad based and relatively similar in manufacturing and services. Where we
do find significant difference is in the coefficients on the industry (subsector) dummy
variables that we include as controls in the regressions. Hence, there is heterogeneity in
the base extent of innovation across industries.
Similarly, it is of interest to assess possible heterogeneity in terms of the vintage
of firms, defined as firms created since a country shifted from a socialist to a market-
oriented strategy of development as compared to firms established under communism. In
particular, we check whether the two types of firms innovate differently in response to
competition, linkages with foreign firms and distance to frontier. The literature provides
some (although limited) guidance here, with new firms typically innovating more than
old firms. The results from estimating the baseline equation separately for firms that
started operating before 1991 (Old) and since 1991 (New) are presented in Table 4. The
results suggest that in two-thirds of the cases there is not a statistically significant
difference in the reaction of the two types of firms. However, in the nine instances (one-
third of cases) where there is a significant difference, the new firms are less responsive
than the old ones. This is the case for low and medium & high elasticity of demand in
obtaining a new license, low pressure from foreign competition in acquiring a new
product, medium and high pressure from foreign competition in obtaining a new license,
share of sales to MNEs in acquiring a new technology, export share in obtaining a new
license, and distance to the frontier in acquiring a new product, technology and license.
24
Moreover, in most cases where the effects are not significantly different, the point
estimates are larger for the old than the new firms. Overall, it appears that in terms of
innovation the old firms tend to be more sensitive to competition, linkages to MNEs and
distance to the frontier than the new firms.
4.5 Testing for Business Environment
We carry out two tests of the effects of differences in business environment. First,
we check whether general differences in levels of development of markets and
institutions, captured by stratifying the sample by historically different regions, affect
innovation and the effect of our three sets of variables. Second we test whether
differences in the level of bribery (corruption) matter.
In Table 5, we present the coefficients from separate estimates of equation (1) for
countries in the Commonwealth of Independent States (CIS), Central Europe and the
Baltic (CEB) and South Eastern Europe, including Turkey (SEE). Since markets and
market oriented institutions are viewed as functioning better in the CEB region than in
the CIS and SEE regions, one may expect that the dispersion of firms in terms of
efficiency would be smaller and firms in CEB would operate more at a neck-and-neck
level and closer to the frontier than firms in CIS and SEE. The Aghion et al. (2005a)
model would predict an inverted U relationship between competition and innovation in
the CEB region and a negative relationship in the two other regions.
The coefficients on elasticity of demand in Table 5 support this prediction. The
CEB coefficients display an inverted U in all three types of innovation, while the
estimates for the other regions mostly generate a negative relationship between
competition and innovation. 8 , 9 Firms in the CEB region also tend to respond more
positively in their innovative behavior to foreign competition, especially vis a vis the SEE
region. The CEB firms also display a more consistent positive effect on innovation of
8
Except for new license in CIS, we reject the hypothesis that the two coefficients in a given column are
jointly zero.
9
We estimated a regression with markup and markup squared, however including higher terms for markup
makes coefficients on markup and higher order terms insignificant.
25
selling to MNEs, a similar effect of importing and a less consistent positive effect of
exporting. Finally, firms in the SEE region show the most systematic pattern of firms that
are further from the frontier innovating less, followed by the CEB firms. The pattern is
absent among firms in CIS.
In Table 6 we present tests of whether more pro-business environment in terms of
lower level of bribery (corruption) induces firms to respond to competition by investing
more in innovations (Acemoglu et al., 2003, Aghion et al., 2005a,b). To carry out this
test we allocate firms into low, medium and high corruption environment category on the
basis of the percentage of annual sales that the firms (“a firm like yours”) pay in
unofficial payments to public officials and estimate equation (1) separately for firms in
each category. The three categories have highly statistically different mean values of
0.005, 0.011 and 0.021, respectively. Overall, there do not appear to be many systematic
differences between the estimated coefficients of firms in the low and high categories of
corruption. The clearest difference is observed in the fact that firms in the low bribery
category have a significant negative relationship between the distance to the frontier and
all three types of innovation, while firms in the middle and high bribery categories
register only insignificant coefficients. In developing a new product, the low bribery
firms are also less responsive to demand elasticity and sales to MNEs, but more
responsive to exporting. In acquiring a new technology and license, the low bribery firms
generate similar patterns of coefficients as high bribery firms.
5. Conclusion
In view of the recent theoretical literature on globalization and innovation, we
have used rich firm-level data from the 27 emerging market economies of the post-
socialist republics to test important predictions relating to the effects of competition and
linkages with foreign firms on domestic firms’ innovation, taking into account firm
heterogeneity (distance to the efficiency frontier). According to Sutton (2007), the
‘middle group’ countries of Eastern Europe should be the most dramatic beneficiaries of
26
globalization, especially from the transfer of capabilities of foreign direct investment.
Our focus on innovation is motivated by the fact that innovation is widely regarded as a
channel through which local firms try to stay competitive in the new global economy.
Our basic finding with respect to competition is that it has a negative effect on
product and technology innovation and an insignificant effect on innovation measured by
acquiring a license or quality accreditation. We do not find the inverted U shaped effect
of competition on innovation proposed by Kamien and Schwartz (1972) and developed
by Aghion et al. (2005a), except when we reduce the number of control variables. Our
basic results are hence more in line with the Schumpeterian view that competition
reduces innovative activity and they suggest that empirical support for the inverted U
hypothesis may be sensitive to the inclusion of control variables. Importantly, we find
that greater pressure from foreign competition stimulates innovation -- an intriguing
result that ought to be explored further in future research.
Vertical transfer of capability from foreign to domestic firms, stressed by Sutton
(2007), appears to be substantial for all three types of innovation that we study. This
result suggests that the supply chain of multinational enterprises and international trade
are important means for domestic firms to raise their capability.
We find mild support for the Aghion et al. (2003, 2005a) hypothesis that firms
that are further away from the frontier are less likely to innovate. However, we find
evidence against the related hypothesis that the inverted U relationship between
competition and innovation ought to hold for firms that are close to the efficiency frontier,
while a negative relationship ought to be found for firms far from the frontier. Finally,
greater foreign competition stimulates all three types of innovation irrespective of the
distance of the firms from the frontier.
A key prediction that we test is that the effects of globalization vary across
different sectors and firms in the economy. We take advantage of our data set and test
whether the innovation effects of competition, vertical linkages with foreign firms and
distance to the frontier are different for manufacturing than service sector firms. The
27
results indicate that the effect is broad-based and relatively similar in manufacturing and
services. We also divide firms into those established under communism and those
created after a country shifted to a market-oriented strategy of development. The results
suggest that in most cases there is not a statistically significant difference, although
innovation in the old firms tends to be more sensitive to competition, transfer of
capability and distance to the frontier than in the new firms. Hence, there do not appear to
be major differences along the sector and firm-vintage dimensions.
Finally, we test the Aghion et al. (2005a) prediction that firms in a more pro-
business environment invest more in innovation and are more likely to display the
inverted U relationship between competition and innovation. Stratifying firms across
regions with different business environments provides support for this prediction.
However, when we proxy the quality of business environment by the extent of bribery
(corruption), we do not find many systematic differences between firms in the low and
high categories of corruption.
Our results are both encouraging and sobering. Whereas the advocates of
globalization and market oriented institutions will be disappointed that competition does
not foster innovation, they will be heartened by the finding that pressure from foreign
competition and linkages with foreign firms (within and outside of the country) do
improve domestic firms’ innovative capacity and that there is some evidence that firms in
more market oriented economies tend to innovate more. Our data set has numerous
strengths but also some limitations. The latter should be overcome in the design of future
surveys.
28
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29
Table 1. Baseline Specification for All Firms.
New New New
Product Technology License
Competition
Markup 0.544*** 0.542*** 0.016
(0.110) (0.112) (0.119)
Elasticity of demand
Low 0.026 0.038 -0.033
(0.035) (0.036) (0.039)
Medium & High -0.103*** -0.163*** -0.057
(0.033) (0.035) (0.037)
Pressure from foreign competition
Low 0.052 0.074** 0.060
(0.035) (0.037) (0.039)
Medium & High 0.107*** 0.146*** 0.100***
(0.032) (0.033) (0.035)
Vertical Transfer of Capability
Share of sales to MNEs 0.224*** 0.198*** 0.403***
(0.067) (0.066) (0.066)
Export share 0.283*** 0.240*** 0.333***
(0.080) (0.074) (0.075)
Import share 0.364*** 0.264*** 0.191***
(0.038) (0.039) (0.041)
Ability
Distance (Mahalanobis) -0.038* -0.040* -0.025
(0.022) (0.022) (0.023)
Controls
lnL, t-3 0.126*** 0.129*** 0.230***
(0.031) (0.033) (0.036)
(lnL)2, t-3 -0.007 -0.006 -0.013***
(0.004) (0.004) (0.005)
Capacity utilization, t-3 -0.527*** -0.302*** -0.276***
(0.063) (0.064) (0.068)
Positive R&D dummy 0.392*** 0.280*** 0.374***
(0.039) (0.037) (0.038)
Share of skilled workers, t-3 0.064 0.007 -0.114**
(0.045) (0.047) (0.051)
Share of workers with Univ. Ed. t-3 0.202*** 0.130** 0.247***
(0.050) (0.053) (0.055)
Firm’s age -0.055*** -0.038* -0.017
(0.020) (0.020) (0.021)
State owned dummy -0.252*** -0.141*** -0.096**
(0.046) (0.047) (0.049)
Compete in national markets 0.225*** 0.201*** 0.267***
(0.033) (0.034) (0.038)
No. of Observations 11,632 11,529 11,632
Note: The table reports estimates of equation (1). Definitions of the variables are in Appendix Table
A1. Robust standard errors are in parentheses and the number of observations is in brackets; *
significant at 10%; ** significant at 5%; *** significant at 1%.
Table 2. Testing for Interaction Between Distance and Competition.
New Good New Technology New License
Distance to the Frontier Distance to the Frontier Distance to the Frontier
Close Middle Far Close Middle Far Close Middle Far
Competition
Markup 0.174 0.593*** 0.807*** 0.896*** 0.419** 0.458*** 0.224 -0.074 -0.102
(0.230) (0.188) (0.170) (0.236) (0.197) (0.167) (0.252) (0.199) (0.186)
Low 0.030 0.016 0.106* 0.058 0.032 0.075 -0.035 0.029 -0.011
(0.062) (0.061) (0.060) (0.064) (0.064) (0.059) (0.068) (0.067) (0.065)
Medium & High -0.137** -0.022 -0.139** -0.131** -0.146** -0.230*** -0.066 -0.031 -0.091
(0.059) (0.057) (0.056) (0.060) (0.061) (0.057) (0.064) (0.062) (0.062)
Low 0.162*** 0.055 0.068 0.103* 0.088 0.136** 0.195*** 0.065 0.053
(0.060) (0.061) (0.061) (0.063) (0.067) (0.062) (0.065) (0.068) (0.069)
Medium & High 0.218*** 0.161*** 0.153*** 0.139** 0.284*** 0.223*** 0.218*** 0.143** 0.223***
(0.053) (0.054) (0.056) (0.056) (0.057) (0.056) (0.057) (0.059) (0.061)
Share of sales to MNEs 0.333*** 0.362*** 0.262** 0.379*** 0.334*** 0.167 0.518*** 0.730*** 0.279**
(0.115) (0.118) (0.115) (0.115) (0.117) (0.110) (0.113) (0.116) (0.111)
Export share 0.432*** 0.419*** 0.532*** 0.432*** 0.400*** 0.423*** 0.498*** 0.664*** 0.691***
(0.138) (0.138) (0.135) (0.127) (0.123) (0.120) (0.129) (0.126) (0.124)
Import share 0.387*** 0.459*** 0.460*** 0.277*** 0.369*** 0.302*** 0.286*** 0.272*** 0.225***
(0.066) (0.066) (0.066) (0.068) (0.068) (0.063) (0.070) (0.069) (0.069)
No. of observations 3,923 3,869 3,845 3,889 3,835 3,816 3,929 3,869 3,845
Note: The table reports estimates of equation (1). Definitions of the variables are in Appendix Table A1. Close denotes the lowest third of firms in terms of
distance to foreign firms; Far denotes the greatest third of firms in terms of distance to foreign firms. Robust standard errors are in parentheses and the number of
observations is in brackets; * significant at 10%; ** significant at 5%; *** significant at 1%.
Table 3. Testing for Heterogeneity: Manufacturing v. Services
New Product New Technology New License
MNFR SERV MNFR SERV MNFR SERV
Competition
Markup 0.520** 0.563*** 0.548*** 0.514*** 0.002 0.024
(0.204) (0.156) (0.187) (0.169) (0.203) (0.178)
Low -0.010 0.015 0.005 0.083 -0.140** 0.072
(0.065) (0.051) (0.060) (0.056) (0.066) (0.060)
Medium & High -0.103* -0.115** -0.131** -0.132** -0.129** 0.050
(0.062) (0.048) (0.058) (0.054) (0.063) (0.057)
Low 0.085 0.026 0.002 0.128** -0.035 0.095
(0.065) (0.051) (0.062) (0.057) (0.070) (0.058)
Medium & High 0.126** 0.126*** 0.088* 0.171*** 0.074 0.102**
(0.055) (0.045) (0.053) (0.051) (0.059) (0.052)
Share of sales to MNEs 0.227** 0.179* 0.246** 0.216** 0.528*** 0.349***
(0.112) (0.101) (0.104) (0.105) (0.104) (0.105)
Export share 0.265** 0.215* 0.273*** 0.209* 0.283*** 0.440***
(0.119) (0.122) (0.104) (0.125) (0.106) (0.125)
Import share 0.450*** 0.281*** 0.224*** 0.253*** 0.280*** 0.107*
(0.071) (0.053) (0.065) (0.058) (0.071) (0.060)
Ability
Distance (Mahalanobis) -0.053 -0.062* -0.027 -0.087** -0.054 0.029
(0.038) (0.034) (0.035) (0.038) (0.038) (0.039)
No. of Observations 3,887 5,596 3,850 5,552 3,887 5,596
Note: The table reports estimates of equation (1). Definitions of the variables are in Appendix Table A1.
MNFR is Manufacturing, SERV is services. Robust standard errors are in parentheses and the number of
Table 4. Testing for Heterogeneity: Old v. New
Old New Old New Old New
Competition
Markup 0.485** 0.557*** 0.586*** 0.517*** -0.050 0.023
(0.219) (0.128) (0.217) (0.131) (0.239) (0.139)
Low -0.057 0.059 -0.000 0.058 -0.124* 0.008
(0.067) (0.042) (0.067) (0.043) (0.072) (0.047)
Medium & High -0.143** -0.080** -0.207*** -0.140*** -0.149** -0.018
(0.065) (0.040) (0.066) (0.041) (0.069) (0.044)
Low 0.175** 0.011 0.144** 0.042 0.107 0.054
(0.071) (0.041) (0.072) (0.044) (0.077) (0.046)
Medium & High 0.133** 0.102*** 0.154** 0.146*** 0.210*** 0.057
(0.062) (0.037) (0.063) (0.039) (0.067) (0.041)
Share of sales to MNEs 0.200* 0.229*** 0.523*** 0.053 0.417*** 0.414***
(0.119) (0.081) (0.116) (0.081) (0.119) (0.080)
Export share 0.373*** 0.252** 0.303** 0.266*** 0.483*** 0.237**
(0.137) (0.099) (0.126) (0.092) (0.130) (0.095)
Import share 0.384*** 0.361*** 0.229*** 0.275*** 0.143* 0.207***
(0.080) (0.044) (0.078) (0.045) (0.084) (0.048)
Ability
Distance (Mahalanobis) -0.078* -0.018 -0.084** -0.015 -0.102** 0.008
(0.042) (0.025) (0.041) (0.026) (0.043) (0.028)
Observations 3,166 8,466 3,148 8,381 3,166 8,466
Note: The table reports estimates of equation (1). Definitions of the variables are in Appendix Table A1.
Old firms are those established before 1991. Robust standard errors are in parentheses and the number of
33
Table 5. Regional Differences
CIS CEB SEE CIS CEB SEE CIS CEB SEE
Competition
Markup 0.610*** 0.481** 0.492** 0.668*** 0.616*** 0.346* 0.198 -0.153 -0.168
(0.171) (0.212) (0.205) (0.169) (0.228) (0.200) (0.177) (0.244) (0.228)
Low 0.015 0.214*** -0.084 0.043 0.095 -0.000 -0.009 0.171* -0.194***
(0.053) (0.076) (0.063) (0.053) (0.081) (0.063) (0.056) (0.090) (0.070)
Medium & High -0.085* 0.055 -0.227*** -0.145*** -0.104 -0.218*** -0.044 0.119 -0.205***
(0.049) (0.070) (0.063) (0.050) (0.076) (0.063) (0.053) (0.084) (0.069)
Low 0.104* 0.146** -0.126* 0.051 0.224*** 0.012 0.044 0.079 0.060
(0.054) (0.068) (0.067) (0.055) (0.075) (0.070) (0.057) (0.079) (0.077)
Medium & High 0.127** 0.240*** -0.044 0.124** 0.228*** 0.151*** 0.098* 0.118* 0.077
(0.052) (0.060) (0.057) (0.052) (0.067) (0.058) (0.054) (0.069) (0.065)
Share of sales to MNEs 0.248** 0.239* 0.154 0.133 0.364*** 0.177* 0.451*** 0.635*** 0.193*
(0.116) (0.130) (0.107) (0.113) (0.130) (0.105) (0.110) (0.131) (0.112)
Export share 0.361** 0.106 0.460*** 0.387*** 0.035 0.304** 0.320** 0.236 0.497***
(0.150) (0.145) (0.133) (0.129) (0.146) (0.123) (0.130) (0.150) (0.128)
Import share 0.418*** 0.353*** 0.295*** 0.325*** 0.155* 0.239*** 0.180*** 0.199** 0.214***
(0.059) (0.073) (0.071) (0.058) (0.080) (0.071) (0.061) (0.084) (0.077)
Ability
Distance (Mahalanobis) 0.015 -0.153*** -0.061 -0.018 -0.046 -0.091** 0.067* -0.041 -0.158***
(0.033) (0.044) (0.043) (0.034) (0.049) (0.041) (0.035) (0.051) (0.046)
Observations 5,010 3,151 3,471 4,964 3,130 3,435 5,010 3,151 3,471
Note: The table reports estimates of equation (1). Definitions of the variables are in Appendix Table A1. CIS stands for Commonwealth Independent States; CEB stands
for Central Europe and Baltic; SEE stands for South East Europe. Robust standard errors are in parentheses and the number of observations is in brackets; * significant
at 10%; ** significant at 5%; *** significant at 1%.
Table 6. Testing for Business Environment: Bribery
Bribery Bribery Bribery
Low Medium High Low Medium High Low Medium High
Competition
Markup 0.468** 0.284 0.793*** 0.775*** 0.305 0.501*** 0.123 0.118 -0.231
(0.201) (0.191) (0.190) (0.203) (0.196) (0.190) (0.226) (0.204) (0.202)
Low 0.076 -0.035 0.026 0.032 -0.016 0.101 0.005 -0.049 -0.067
(0.065) (0.060) (0.061) (0.066) (0.061) (0.062) (0.074) (0.065) (0.067)
Medium & High -0.076 -0.107* -0.118** -0.153** -0.155*** -0.163*** -0.035 -0.117* -0.023
(0.062) (0.057) (0.057) (0.064) (0.059) (0.059) (0.071) (0.063) (0.062)
Low 0.014 0.097 0.063 0.154** -0.017 0.089 0.067 0.030 0.082
(0.063) (0.062) (0.060) (0.066) (0.065) (0.061) (0.074) (0.069) (0.064)
Medium & High 0.094* 0.110** 0.132** 0.231*** 0.083 0.126** 0.166*** 0.066 0.089
(0.055) (0.054) (0.055) (0.058) (0.056) (0.057) (0.064) (0.059) (0.059)
Share of sales to MNEs 0.115 0.362*** 0.246** 0.299*** 0.206 0.138 0.520*** 0.252** 0.440***
(0.103) (0.136) (0.119) (0.101) (0.127) (0.118) (0.105) (0.128) (0.118)
Export share 0.456*** 0.093 0.167 0.205* 0.332** 0.144 0.244** 0.569*** 0.202
(0.127) (0.149) (0.147) (0.117) (0.145) (0.137) (0.119) (0.148) (0.139)
Import share 0.323*** 0.397*** 0.361*** 0.190*** 0.258*** 0.345*** 0.268*** 0.174** 0.169**
(0.066) (0.068) (0.068) (0.068) (0.068) (0.068) (0.074) (0.072) (0.072)
Ability
Distance (Mahalanobis) -0.087** -0.017 -0.019 -0.072* -0.046 0.011 -0.109** 0.011 0.049
(0.040) (0.040) (0.038) (0.041) (0.041) (0.038) (0.044) (0.044) (0.040)
Observations 3,749 3,942 3,933 3,718 3,906 3,903 3,749 3,942 3,936
Note: The table reports estimates of equation (1). Definitions of the variables are in Appendix Table A1. Low denotes the lowest third quantity in terms of bribery made.
Robust standard errors are in parentheses and the number of observations is in brackets; * significant at 10%; ** significant at 5%; *** significant at 1%.
35
Appendix Table A1. Definitions.
Variable Name Variable Definition BEEPS question
newgood New good or Dummy variable. Has your company undertaken any of the following initiatives over the last 36
upgrade existing months? Dummy variable is equal to one if ‘yes’ to any of the two questions:
good - Developed successfully a major new product line
- Upgraded an existing product line
newtech New technology is Dummy variable = 1 if answer is affirmative to question: Has your firm acquired new production
implemented technology over the last 36 months?
newlice New license is Dummy variable.
received Has your company undertaken any of the following initiatives over the last 36 months? Dummy
variable is equal to one if ‘yes’ to any of the two questions
- Obtained a new quality accreditation (ISO 9000, 9002 or 14,000, AGCCP, etc)
- Obtained a new product licensing agreement
neworg New organization Dummy variable.
structure Which of the following best describes the organization of departments (in terms of the allocation of
responsibilities, budgetary resources and staff) within your firm over the last 36 months? Set equal
to one if a firm has chosen one of the following options:
- My firm has had major reallocations of responsibility and resources between departments
- My firm has had a completely new organizational structure
Markup Markup Considering your main product line or main line of services in the domestic market, by what margin
does your sales price exceed your operating costs (i.e., the cost material inputs plus wage costs but
not overheads and depreciation)?
DE Elasticity of demand Now I would like to ask you a hypothetical question. If you were to raise your prices of your main
product line or main line of services 10% above their current level in the domestic market (after
allowing for any inflation) which of the following would best describe the result assuming that your
competitors maintained their current prices?
Inelastic Our customers would continue to buy from us in the same quantities as now
Low Our customers would continue to buy from us, but at slightly lower quantities
Medium Customers would continue to buy from us, but at much lower quantities
High Many of our customers would buy from our competitors instead
ForComp Pressure from How would you rate the importance of pressure from foreign competition on key decisions about
foreign competition your business with respect to “Reducing the production costs of existing products or services”:
None Not important
Low Slightly important
Medium Fairly important
High Very important
SMNE Share of sales to Share of sales to multinationals located in your country (not including your parent company, if
MNEs applicable)
EXPORT Export share Share of sales exported directly or indirectly through a distributor
IMPORT Import share Share of your firm’s material inputs and supplies that are imported directly or indirectly through a
distributor
L Labor Permanent and temporary employees 36 month ago
(continued on next page)
CU Capacity utilization In your judgment, what is your firm’s output in comparison with the maximum output possible using
its facilities/man power at the time 36 months ago? If you are using the facilities/man power to the
full, answer 100%; if output was 60% of capacity, answer 60%.
R&D Positive R&D = 1 if positive expenditures on research and development (including wages and salaries of R&D
dummy personnel, materials, R&D related education and training costs) in previous year;
=0 otherwise
SKILL Share of skilled What share of your current permanent, full-time workers are skilled workers 36 months ago?
workers, 3 yrs ago
EDU Share of workers What share of the workforce at your firm has some university education in 36 months ago?
with higher
education, 3yrs ago
LS Share held by the What percentage of your firm does the largest shareholder(s) own?
largest owner
Age Log (Firm’s age ) Year or survey minus the year when the firm was established. For the year established: In what year
did your firm begin operations in this country?
SOE State owned Government is the major shareholder (50%+)
CNM Compete in national Does your firm compete in the national market (i.e. whole country) for its main product line or
markets service or does it serve primarily the local market (i.e. region, city, or neighborhood)?
LOC Location Type of location: Capital; Other, over 1 million; Other,250,000-1,000,000; Other, 50,000-250,000;
Under 50,000
BR Bribes On average, what percent of total annual sales do firm’s like yours typically pay in unofficial
payments/gifts to public officials?
37
Appendix Table A2.1. Summary Statistics.
N Mean SD
Innovation Variables
New Good 11632 0.5624 0.4961
New Technology 11529 0.3027 0.4595
New License 11632 0.2210 0.4150
Competition
Markup 11632 0.2092 0.1186
Low 11632 0.3031 0.4596
Medium&High 11632 0.4771 0.4995
Low 11632 0.1733 0.3785
Medium&High 11632 0.2976 0.4572
Share of sales to MNEs 11632 0.0667 0.1967
Export share 11632 0.0691 0.1871
Import share 11632 0.2586 0.3591
Ability
Distance (Mahalanobis) 11632 3.0342 0.7064
Distance(Solow) 5548 0.3640 0.3775
Controls
lnL, 3yrs ago 11632 3.0004 1.6049
(lnL)2, 3yrs ago 1163211.577711.5304
Capacity utilization, 3yrs ago 11632 0.7948 0.2060
Positive R&D dummy 11632 0.1632 0.3695
Share of skilled workers, 3yrs ago 11632 0.4873 0.3097
Share of workers with higher education, 3yr ago 11632 0.2723 0.2902
Firm’s age 11632 2.3673 0.7772
State owned 11632 0.1182 0.3229
Compete in national markets 11632 0.6673 0.4712
38
Appendix Table A2.2. Summary statistics for innovation variables by age and industry.
MNFR SERV OLD NEW
N Mean SD N Mean SD N Mean SD N Mean SD
Innovation Variables
New Good 3887 0.6985 0.4590 5596 0.4737 0.4994 3166 0.5657 0.4957 8466 0.5612 0.4963
New Technology 3850 0.4200 0.4936 5552 0.2151 0.4109 3148 0.3297 0.4702 8381 0.2926 0.4550
New License 3887 0.2447 0.4299 5596 0.1907 0.3929 3166 0.2502 0.4332 8466 0.2101 0.4074
Competition
Markup 3887 0.2135 0.1171 5596 0.2084 0.1200 3166 0.2025 0.1153 8466 0.2117 0.1197
Elasticity of demand:
Low 3887 0.3244 0.4682 5596 0.2922 0.4548 3166 0.2903 0.4540 8466 0.3079 0.4617
Medium&High 3887 0.4703 0.4992 5596 0.4971 0.5000 3166 0.4618 0.4986 8466 0.4829 0.4997
Pressure from foreign competition:
Low 3887 0.1888 0.3914 5596 0.1678 0.3737 3166 0.1699 0.3756 8466 0.1746 0.3796
Medium&High 3887 0.4196 0.4936 5596 0.2541 0.4354 3166 0.3389 0.4734 8466 0.2822 0.4501
Share of sales to MNEs 3887 0.0831 0.2143 5596 0.0545 0.1806 3166 0.0768 0.2086 8466 0.0629 0.1919
Export share 3887 0.1194 0.2399 5596 0.0485 0.1564 3166 0.1049 0.2227 8466 0.0558 0.1700
Import share 3887 0.2860 0.3602 5596 0.2558 0.3687 3166 0.2435 0.3399 8466 0.2643 0.3659
Ability
Distance (Mahalanobis) 3887 3.0739 0.7707 5596 2.8814 0.6067 3166 3.0719 0.7115 8466 3.0201 0.7041
Distance(Solow) 1854 0.3108 0.3249 2838 0.4418 0.3688 1506 0.2746 0.3549 4042 0.3973 0.3803
Controls
lnL, 3yrs ago 3887 3.3480 1.6173 5596 2.6431 1.5288 3166 3.9332 1.7022 8466 2.6515 1.4172
(lnL)2, 3yrs ago 3887 13.8245 12.3381 5596 9.3229 10.3920 3166 18.3669 13.8859 8466 9.0388 9.3219
Capacity utilization, 3yrs ago 3887 0.7728 0.2119 5596 0.8081 0.2029 3166 0.7837 0.2103 8466 0.7989 0.2042
Positive R&D dummy 3887 0.2076 0.4057 5596 0.1201 0.3251 3166 0.2236 0.4167 8466 0.1406 0.3476
Share of skilled workers, 3yrs ago 3887 0.5541 0.2714 5596 0.4278 0.3315 3166 0.5190 0.2893 8466 0.4755 0.3162
Share of workers with higher
education, 3yr ago 3887 0.2167 0.2349 5596 0.3155 0.3207 3166 0.2357 0.2506 8466 0.2859 0.3025
Firm’s age 3887 2.4911 0.8069 5596 2.2592 0.7256 3166 3.3746 0.5963 8466 1.9906 0.4191
State owned 3887 0.0936 0.2914 5596 0.1110 0.3141 3166 0.2896 0.4537 8466 0.0541 0.2262
Compete in national markets 3887 0.6877 0.4635 5596 0.6521 0.4764 3166 0.7382 0.4397 8466 0.6408 0.4798
Appendix Table A2.3. Summary statistics for innovation variables by country.
New
New Good New Technology New License New Good New License
Country Technology
N Mean SD N Mean SD N Mean SD Divide each by total mean
Yugoslavia 375 0.6853 0.4650 374 0.3850 0.4873 375 0.1760 0.3813 1.2186 1.2719 0.7963
Macedonia 268 0.5522 0.4982 263 0.3118 0.4641 268 0.1269 0.3334 0.9819 1.0300 0.5740
Albania 257 0.6070 0.4894 256 0.3516 0.4784 257 0.2023 0.4025 1.0793 1.1614 0.9154
Croatia 213 0.8404 0.3671 209 0.4833 0.5009 213 0.2160 0.4125 1.4942 1.5964 0.9771
Turkey 767 0.3455 0.4758 750 0.2027 0.4023 767 0.1160 0.3205 0.6143 0.6695 0.5250
Bosnia 225 0.6533 0.4770 220 0.4273 0.4958 225 0.1956 0.3975 1.1617 1.4115 0.8848
Slovenia 323 0.3684 0.4831 323 0.3096 0.4630 323 0.2879 0.4535 0.6551 1.0227 1.3027
Poland 1162 0.5843 0.4930 1159 0.3192 0.4664 1162 0.1661 0.3723 1.0390 1.0546 0.7515
Ukraine 791 0.6713 0.4700 789 0.3295 0.4703 791 0.2162 0.4119 1.1936 1.0886 0.9781
Belarus 409 0.7286 0.4452 408 0.3039 0.4605 409 0.3350 0.4726 1.2955 1.0040 1.5155
Hungary 615 0.4260 0.4949 615 0.1398 0.3471 615 0.2602 0.4391 0.7575 0.4619 1.1771
Czech Republic 354 0.4294 0.4957 352 0.2131 0.4101 354 0.1638 0.3707 0.7635 0.7039 0.7413
Slovakia 269 0.7361 0.4416 267 0.2472 0.4322 269 0.1970 0.3985 1.3088 0.8166 0.8914
Romania 646 0.6703 0.4705 643 0.3872 0.4875 646 0.2895 0.4539 1.1918 1.2792 1.3097
Bulgaria 397 0.5693 0.4958 397 0.2620 0.4403 397 0.2368 0.4256 1.0122 0.8654 1.0712
Moldova 352 0.6364 0.4817 349 0.3209 0.4675 352 0.2472 0.4320 1.1315 1.0601 1.1182
Latvia 238 0.5882 0.4932 237 0.2827 0.4513 238 0.2941 0.4566 1.0459 0.9339 1.3307
Lithuania 292 0.6096 0.4887 284 0.2852 0.4523 292 0.3014 0.4596 1.0839 0.9422 1.3635
Estonia 221 0.5792 0.4948 216 0.2083 0.4071 221 0.2217 0.4163 1.0298 0.6882 1.0031
Georgia 242 0.4628 0.4996 242 0.2686 0.4441 242 0.1860 0.3899 0.8229 0.8873 0.8413
Armenia 413 0.5956 0.4914 413 0.4358 0.4965 413 0.1235 0.3294 1.0591 1.4398 0.5587
Kazakhstan 680 0.4897 0.5003 677 0.2629 0.4405 680 0.2221 0.4159 0.8707 0.8686 1.0047
Azerbaijan 398 0.5553 0.4976 375 0.3813 0.4864 398 0.2990 0.4584 0.9873 1.2597 1.3527
Uzbekistan 404 0.3614 0.4810 403 0.2258 0.4186 404 0.1906 0.3933 0.6426 0.7459 0.8623
Russia 779 0.5687 0.4956 766 0.3003 0.4587 779 0.2940 0.4559 1.0111 0.9919 1.3300
Tajikistan 304 0.5757 0.4951 304 0.3487 0.4773 304 0.2303 0.4217 1.0235 1.1519 1.0418
Kyrgyzstan 238 0.6134 0.4880 238 0.3992 0.4908 238 0.2437 0.4302 1.0907 1.3186 1.1026
Total 11632 0.5624 0.4961 11529 0.3027 0.4595 11632 0.2210 0.4150 1.0000 1.0000 1.0000
40
Appendix Table A2.4. Summary statistics for innovation variables by industry.
New New New
Good Technology License
Industry N Mean SD N Mean SD N Mean SD Divide each by total mean
mining and quarrying 106 0.6132 0.4893 105 0.3333 0.4737 106 0.3396 0.4758 1.0903 1.1011 1.5366
food and tobacco 1096 0.7071 0.4553 1086 0.4540 0.4981 1096 0.2573 0.4373 1.2573 1.4996 1.1641
textile and leather 685 0.6496 0.4774 674 0.3309 0.4709 685 0.1460 0.3533 1.1551 1.0930 0.6605
wood 105 0.7524 0.4337 104 0.3462 0.4780 105 0.1810 0.3868 1.3378 1.1435 0.8187
paper and publishing 228 0.6798 0.4676 227 0.4493 0.4985 228 0.1711 0.3774 1.2088 1.4844 0.7739
coke, chemicals and rubber 209 0.7943 0.4052 208 0.4231 0.4952 209 0.3254 0.4696 1.4122 1.3976 1.4720
non-metallic 150 0.7000 0.4598 147 0.4082 0.4932 150 0.2267 0.4201 1.2446 1.3483 1.0255
metal 622 0.6640 0.4727 619 0.4362 0.4963 622 0.2508 0.4338 1.1806 1.4409 1.1347
machinery and equipment 583 0.7050 0.4564 578 0.4377 0.4965 583 0.3636 0.4815 1.2535 1.4460 1.6452
recycling 209 0.7943 0.4052 207 0.4444 0.4981 209 0.1962 0.3981 1.4122 1.4682 0.8875
constructions 1374 0.5378 0.4987 1357 0.3220 0.4674 1374 0.3086 0.4621 0.9563 1.0638 1.3961
trade 3168 0.4501 0.4976 3139 0.1829 0.3866 3168 0.1828 0.3865 0.8003 0.6041 0.8269
hotel 736 0.4769 0.4998 730 0.2164 0.4121 736 0.1372 0.3443 0.8480 0.7150 0.6209
transportation 716 0.5168 0.5001 714 0.2843 0.4514 716 0.2696 0.4440 0.9188 0.9392 1.2195
finance, real estate 976 0.5164 0.5000 969 0.2673 0.4428 976 0.1988 0.3993 0.9182 0.8830 0.8993
public administration, education, health 669 0.5561 0.4972 665 0.3113 0.4634 669 0.1390 0.3462 0.9887 1.0283 0.6289
Total 11632 0.5624 0.4961 11529 0.3027 0.4595 11632 0.2210 0.4150 1.0000 1.0000 1.0000
41
Appendix Table A3. Baseline Specification for All Firms using Solow distance
New
New Product New License
Technology
Competition
Markup 0.471*** 0.096 -0.118
(0.172) (0.168) (0.178)
Low -0.042 0.048 -0.023
(0.057) (0.055) (0.059)
Medium&High -0.196*** -0.199*** -0.084
(0.054) (0.053) (0.056)
Low 0.056 0.082 0.038
(0.054) (0.055) (0.058)
Medium&High 0.127** 0.180*** 0.095*
(0.049) (0.049) (0.052)
Share of sales to MNEs 0.397*** 0.210** 0.312***
(0.108) (0.097) (0.099)
Export share 0.259** 0.137 0.181*
(0.116) (0.104) (0.105)
Import share 0.411*** 0.223*** 0.114*
(0.059) (0.058) (0.061)
Ability
Distance (Solow) -0.049** -0.045* -0.050**
(0.024) (0.024) (0.025)
Controls
lnL, 3yrs ago 0.147*** 0.127** 0.246***
(0.048) (0.050) (0.055)
(lnL)2, 3yrs ago -0.011* -0.009 -0.013*
(0.007) (0.007) (0.007)
Capacity utilization, 3yrs ago -0.437*** -0.102 -0.237**
(0.103) (0.099) (0.104)
Positive R&D dummy 0.309*** 0.252*** 0.374***
(0.054) (0.051) (0.051)
Share of skilled workers, 3yrs ago 0.060 0.044 -0.116
(0.071) (0.073) (0.077)
Share of workers with higher education, 3yrs ago 0.123 0.075 0.169*
(0.085) (0.086) (0.089)
Firm’s age -0.027 -0.036 -0.009
(0.031) (0.030) (0.031)
State owned -0.389*** -0.199*** -0.198***
(0.072) (0.072) (0.074)
Compete in national markets 0.259*** 0.249*** 0.257***
(0.051) (0.053) (0.057)
Observations 5,033 4,990 5,029
Note: The table reports estimates of equation (1). Definitions of the variables are in Appendix Table A1. Solow residual is
calculated using a Cobb-Douglas production function, where the dependent variables is growth rate of sales revenues; the
independent variables include three inputs (number of employees, capital, capacity utilization), country and industry fixed
effects, and the reported variables. Solow residual distance is the logarithm of ratio the top (country, industry) foreign
firm's Solow residual to that of a domestic firm. Robust standard errors are in parentheses and the number of observations
is in brackets; * significant at 10%; ** significant at 5%; *** significant at 1%.
Appendix Table A4.1. Testing for Endogeneity: Competition Variables
2002 & 2005 2002 & 2005 2002 & 2005
Full Sample 2005 Panel 2005 Panel Full Sample 2005 Panel 2005 Panel Full Sample 2005 Panel 2005 Panel
Panel Panel Panel
(current) (current) (lagged) (current) (current) (lagged) (current) (current) (lagged)
(current) (current) (current)
(a) (b) (c) (d) (a) (b) (c) (d) (a) (b) (c) (d)
Markup 0.593*** 0.557** 0.380 0.310 0.460*** -0.100 -0.524 0.654* -0.006 0.031 0.011 -0.170
(0.098) (0.237) (0.312) (0.367) (0.100) (0.243) (0.328) (0.375) (0.105) (0.250) (0.346) (0.394)
Low 0.085*** 0.204*** 0.304*** -0.016 0.052* 0.082 0.101 0.033 0.016 0.100 0.102 0.099
(0.031) (0.077) (0.108) (0.112) (0.031) (0.077) (0.110) (0.111) (0.034) (0.083) (0.117) (0.119)
Medium&High -0.075*** -0.032 -0.019 -0.091 -0.182*** -0.225*** -0.328*** -0.165 -0.064** 0.036 0.003 0.039
(0.029) (0.072) (0.102) (0.104) (0.030) (0.074) (0.105) (0.106) (0.032) (0.077) (0.112) (0.113)

Low 0.159*** 0.297*** 0.331*** 0.154 0.154*** 0.186** 0.395*** 0.342*** 0.153*** 0.244*** 0.227* 0.097
(0.032) (0.078) (0.112) (0.110) (0.033) (0.079) (0.112) (0.109) (0.035) (0.082) (0.117) (0.116)
Medium&High 0.276*** 0.123* 0.084 0.218** 0.261*** 0.176** 0.351*** 0.168* 0.286*** 0.189*** 0.158 0.065
(0.027) (0.069) (0.098) (0.093) (0.028) (0.070) (0.102) (0.097) (0.030) (0.072) (0.106) (0.097)
Note: Markup, Elasticity of Demand, and Pressure from Foreign Competition each enter the regressions separately. Robust standard errors are in parentheses and the
number of observations is in brackets; * significant at 10%; ** significant at 5%; *** significant at 1%.
Appendix Table A4.2. Testing for Endogeneity: Vertical Transfer and Distance
2002 & 2005 2002 & 2005 2002 & 2005
Full Sample 2005 Panel 2005 Panel Full Sample 2005 Panel 2005 Panel Full Sample 2005 Panel 2005 Panel
Panel Panel Panel
(current) (current) (lagged) (current) (current) (lagged) (current) (current) (lagged)
(current) (current) (current)
(a) (b) (c) (d) (a) (b) (c) (d) (a) (b) (c) (d)
Sales to MNEs 0.308*** 0.356*** 0.191 0.305*** 0.213*** 0.158** 0.065 0.264** 0.344*** 0.374*** 0.294** 0.366***
(0.033) (0.083) (0.120) (0.108) (0.032) (0.079) (0.119) (0.108) (0.033) (0.079) (0.122) (0.109)
Export share 0.296*** 0.463*** 0.444*** 0.371*** 0.213*** 0.204*** 0.315*** 0.189* 0.423*** 0.494*** 0.466*** 0.442***
(0.032) (0.084) (0.115) (0.116) (0.031) (0.076) (0.109) (0.110) (0.033) (0.079) (0.112) (0.114)
Import share 0.368*** 0.338*** 0.319*** 0.182** 0.307*** 0.255*** 0.283*** 0.146 0.212*** 0.190*** 0.298*** 0.125
(0.025) (0.061) (0.088) (0.086) (0.026) (0.064) (0.092) (0.091) (0.028) (0.067) (0.098) (0.094)
Distance -0.051** -0.109** -0.105 -0.103 -0.058*** -0.023 -0.024 -0.026 -0.061*** -0.029 0.002 0.011
(Mahalanobis) (0.020) (0.053) (0.077) (0.077) (0.020) (0.052) (0.074) (0.075) (0.021) (0.056) (0.080) (0.080)
Distance -0.228*** -0.396*** -0.297* -0.311* -0.208*** -0.150 -0.122 -0.123 -0.517*** -0.432*** -0.583*** -0.583***
(Solow) (0.047) (0.104) (0.163) (0.164) (0.048) (0.101) (0.164) (0.164) (0.052) (0.114) (0.202) (0.202)
Note: Vertical Transfer of Capability (sMNE, Export, Import), Mahalanobis Distance and Solow residual Distance enter the regressions separately. Full Sample is with
current RHS values); 2002&2005 Panel is with current RHS values; 2005 Panel is with both current and lagged RHS values. Sales to MNEs, Export share, and Import
share are set as dummy variables equal to one for positive values. Robust standard errors are in parentheses and the number of observations is in brackets; * significant
at 10%; ** significant at 5%; *** significant at 1%.
44

Globalization and Innovation in Emerging Markets

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Globalization and Innovation in Emerging Markets

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GLOBALIZATION AND INNOVATION IN EMERGING MARKETS

Yuriy Gorodnichenko Jan Svejnar Katherine Terrell

Acknowledgements: We would like to thank Xiaoyang Li for valuable research assistance

Griffith, Howitt, and Prantl (2006) to examine the determinants of innovation by

and upgrading of the quality of their products.

negative effect on product and technology innovation (Schumpeter-Acemoglu-Aghion et

to display the inverted U relationship between competition and innovation.

2. Conceptual Framework and Review of Related Empirical Literature

by higher quality firms in advanced economies.

An important prediction of the Sutton (2007) model is that after an initial

economies through the supply chain of multinational enterprises (MNEs). In fact, he

industry and country or regional levels.

A related theoretical framework has been advanced in a series of recent papers by

(2006). In these Schumpeterian models firms or industries operate within a range

(window) of efficiency and increased competition associated with liberalization and

particular, firms/industries close to the frontier are expected to be spurred by competition

threat of entry (competition) by investing in new technologies and production processes.

Aghion et al. (2005a) develop an even sharper theoretical prediction, proposed

operate at similar technological levels (neck-and-neck sectors), while a negative

(Schumpeterian) effect of competition on innovation should dominate in sectors where

innovations are made by laggard firms with low initial profits.

evidence in order to place our results in a comparative perspective.

indicator and citation-weighted patents as a measure of innovation, the authors find an

inverted U effect of competition on innovation.

period 1980-97 to find that entry liberalization (de-licensing) increased within-industry

inequality in output, labor productivity and total factor productivity.

Aghion et al. (2006) combine a variety of US and UK data sources to create a

technologically advanced entry by foreign firms has a positive effect on innovation in

productivity growth interacts negatively with the distance to frontier.

governance) may have validity.

and countries, we test the following predictions derived in the literature:

1. Globalization stimulates innovation by domestic firms through the supply chain of

MNEs (transfer of capabilities);

3. Globalization increases competition, whose effect on innovation is complex:

a. In general the effect of competition on innovation is hypothesized to have

b. The inverted U is steeper in sectors where firms operate at similar

technological levels (neck-and-neck);

c. A negative relationship between competition and innovation dominates in

the efficiency frontier);

by investing in new technologies and other innovations.

3. Data and Econometric Specification

Environment and Enterprise Performance Survey (BEEPS), a joint initiative of the

questionnaires. In each country, the sectoral composition of the sample in terms of

manufacturing2 versus services3 was to be determined by their relative contribution to

especially when we use many control variables.

other appropriability methods such as technological complexity, industrial secrecy, and

rather than in generating new inventions.

In this study, we define innovation broadly as the development of new products,

adoption of new technologies or obtaining of licenses and quality certifications. Within

product innovation we consider ‘major new product lines’ as well as ‘upgrading an

undertaken any of the following initiatives in the last three years:

• Acquired new production technology -- hereafter New Technology;

• Obtained a new product licensing agreement or a new quality accreditation

and New License, respectively, are dummy variables.

likely to have similar efficiency. Conversely, if the observed characteristics of domestic

Mahalanobis distance of domestic firm i to a foreign firm is equal to:

companies, respectively, and Sx is the covariance matrix of the vector of observed

employees and number of establishments; the structure of employment (educational

managers, share of professional workers; share of permanent workers), capacity

utilization in terms of machinery and labor, markup, share owned by largest

and 2005 BEEPS for domestically owned firms:

I isct = Φ {α0 Markupisct + α1DEisct + α 2 ForCompisct +