Innovation and productivity in Latin America

There is a general consensus on the positive relationship between research and development (R&D), innovation, and productivity at the firm level. However, does this relationship

The results confirm that LAC firms are more likely to introduce product or process innovation if they invest more in innovation. More specifically,in Latin America a 10 per cent increase in R&D spending on average results in a 1.7% increase in the probability of a firm innovating, and in a 1.6% increase in innovative sales.Moreover, innovation has a significant effect on productivity performance in the LAC region, where the labor productivity of firms that are innovative is on average 50% higher than that of firms that do not engage in innovation.

Measuring the effect of innovation in productivity

Crépon, Duguet, and Mairesse (1998) were the first to empirically integrate the relationship between R&D, innovation, and productivity at the firm level. Their model is called CDM from their initials and it is structured in three stages:The first stage captures the decision making process related with innovation expenditure. In this stage the model estimates a function that reflects the decision of firms to invest in innovation. The second stage is an innovation function that relates predicted innovation expenditures (and other explanatory variables)to indicators of product and process innovation. The third and final stage of the CDM model focuses on the effects of innovation performance on labor productivity using a standard Cobb Douglas production function with constant returns to scale, predicted innovation and capital and labor inputs. In sum the CDM model allows to estimate the productivity returns to investments in innovation.

Returns not the same for all LA firms

One of the main results of this book is that the returns to investments ininnovation andhuman capital are not identicalacross firms. Innovation has much larger effects on the firms that are already more productive than others. For the 10 percent most productive firms, the increase in productivity due to innovation is no less than 6.6 percent versus 3.0-3.3 percent for the other firms.Similarly, the premium of an increase of 10 percent of investment in human capital is 7.7 percent for the most productive firms, and only 1.7 percent for the least productive ones.

The role of Public Policy

In Latin America and the Caribbean a large variety of industrial and innovation policies try to adopt a microeconomic focus. However, this is not mirrored by increasing volumes, and the size and scope of these government programs across LAC remains limited. For example, Brazil invests 0.085 percent of its GDP to support small- and medium-sized enterprises, while in the United States this figure is nearly five times as high.

Approximately 10.7 percent of LAC’s firms report having received some public support over the previous three years since 2010. However,only 6.6 percent of micro firms and 9.4 percent of small firms reported having received support, in comparison with 14.4 percent of medium-sized firms and 15.8 percent of large firms. In spite of the demonstrated benefits associated to participating in multiple programs, only a small fraction of firms participate in two or more programs (2.9 percent).

In sum, while many public programs in the region are often designed to support SMEs, our results show that large firms are using them disproportionally more. The targeting capacity of the institutions delivering such programs in LAC remains limited.

Access to finance in LA firms

Firms often mention lack of access to bank credit as one of the main constraints on growth, productivity, innovation, and export capacity. The lack of access to finance affects particularly to the small and medium-sized enterprises (SMEs).

The book shows that although access to bank credit enhances firm growth and productivity, its use is extremely limited for micro and young firms, while it is the second source of finance for large firms. More productive firms rely less on internal funding for working capital and tend to use more bank and trade credit. Access to bank credit is quite heterogeneous between countries. In Mexico, less than 30 percent of firms have an overdraft, a line of credit, or a loan, whereas in Brazil, Colombia, and Chile, the numbers are much higher and Argentinean firms are somewhere in the middle.

Larger and older firms, as well as exporters, are more likely to demand bank credit. Smaller, younger, and more domestically oriented companies are often discouraged to borrowand more likely to be financially constrained. Moreover, foreign banks in LAC improve firms’ access to finance only under special circumstances.

Global Value Chain and Exports

The book confirms that access to international markets matters for LAC firms. The participation in international trade and the presence of inward foreign direct investment positively influence labor productivity, while controlling for the heterogeneity of firms.

Moreover, the book adds an important new element to the analysis of firms’ participation in international markets: the nature of the integration of firms in Global Value Chains (GVCs). This has at least two important dimensions: the participation in GVCs, as such, and the positioning of firms along the value chain, whether more upstream (closer to primary resource processing and manufacturing) or downstream (closer to the market, in the assembly and commercial phases of the chain).

The authors focus on four large Latin American countries (Argentina, Brazil, Chile, and Mexico), and show that firms’ participation in GVCsimproves their productivity. Furthermore, the role of firms’ position along the GVC is also confirmed: firms operating “upstream” in the GVC, typically in industries that export primary goods and intermediates that are used in other countries’ exports, tend to be, ceteris paribus, more productive than those firms that operate in industries whose value added comes primarily from processing imported inputs. Being upstream in a GVC has a positive impact on firms’productivity in these four American countries.

Firms in the Caribbean at a glance

The book also contains new micro-evidence on the Caribbean where information has been scarce or non-existent.The firms in this region tend to be micro or small, concentrated in the services sector, mature, and non-exporters. Comparing firms in different Caribbean countries, various differences emerge: smaller countries typically have a higher percentage of micro and small firms, the concentration in the services sector varies from 50 percent to 84 percent, and there are considerable differences in ICT penetration rates.

Ourresults show that innovative firms tend to be more productive than non-innovative firms; innovation matters for firm productivity performance also in the Caribbean economies. Firms that export and are larger are more likely to invest in innovation, while having patent protection or foreign ownership does not significantly predict the decision to invest in innovation.

The more relevant obstacles that Caribbean firms declare to face are the scarcity of adequately educated workers – which limits the capacity to absorb external technology and knowledge–, firms’ difficulty in getting access to finance, inefficient electricity services, and high tax rates.