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Journal Article•DOI•

Endogenous product versus process innovation and a firm's propensity to export

Sascha O. Becker1, Peter Egger2•
University of Stirling1, ETH Zurich2
01 Feb 2013-Empirical Economics (Springer-Verlag)-Vol. 44, Iss: 1, pp 329-354
TL;DR: In this article, the authors provided an empirical analysis of the effects of new product versus process innovations on export propensity at the firm level. And they investigated these hypotheses in a rich survey panel data set with information about new innovations of either type.
Abstract: This article provides an empirical analysis of the effects of new product versus process innovations on export propensity at the firm level. Product innovation is a key factor for successful market entry in models of creative destruction and Schumpeterian growth. Process innovation helps securing a firm’s market position given the characteristics of its product supply. Both modes of innovation are expected to raise a firm’s propensity to export. According to new trade theory, we conjecture that product innovation is relatively more important in that regard. We investigate these hypotheses in a rich survey panel data set with information about new innovations of either type. With a set of indicators regarding innovation motives and impediments and continuous variables at the firm and industry level at hand, we may determine the probability of launching new innovations and their impact on export propensity at the firm level through a double treatment approach.

Summary (3 min read)

Jump to: [1 Introduction] – [2.1 Economic theory on innovation] – [2.2 Empirical work on the determinants and effects of] – [2.3 Contribution of this paper] – [3 Empirical framework] – [4 Data] – [4.1 Dependent variables] – [4.2 Independent variables] – [5 Estimation results] – [6 Sensitivity analysis and discussion] and [7 Conclusions]

1 Introduction

  • Research on the role of innovation on economic outcome has for long been at the heart of three different fields of the profession: macro-economics, international economics, and industrial economics.
  • To a large extent, product and/or process characteristics and the corresponding modes of innovation are typically viewed to be beyond a firm’s choice.
  • The latter is, however, largely at odds with both economic intuition and stylized facts.
  • The next section provides an overview of earlier theoretical and empirical work on innovation to motivate determinants of innovations and derive hypotheses about their consequences for productivity and export propensity.
  • Section 4 summarizes the main features of their survey data.

2.1 Economic theory on innovation

  • There is a sizeable body of theoretical work that elaborates on the determinants of innovation and their consequences for productivity and economic growth and, to a lesser extent, for exports.
  • As indicated before, innovation is endogenous itself and firms innovate more likely in large economies (where fixed costs can be covered more easily), if the productivity in research labs is high, product markets are competitive, and if consumers value a large variety and/or a high quality of available products (see Grossman and Helpman, 1991, chapters 3 and 4).
  • While both process and product innovation spur aggregate income, product innovation is preferable by avoiding the adverse effects of technological unemployment.
  • There, investment in firm-specific assets (to be associated with product innovation, see Spence, 1984) and a high corresponding outcome (i.e., a high total factor productivity) are the key determinants of a firm’s export propensity.
  • When assuming that the aggregate efficiency can be measured by the (inverse of) average production costs, then, Boone’s (2000) analysis suggests that a higher level of competitive pressure cannot increase product and process innovation at the same time.

2.2 Empirical work on the determinants and effects of

  • Two exceptions in the latter regard are Cassiman and Mart́ınezRos (2004) and Lachenmaier and Wößmann (2006).
  • Both studies exploit information from panel data.
  • Cassiman and Mart́ınez-Ros (2004) focus on innovations as such and treat them as predetermined variables (hence, they use once-lagged instead of contemporaneous innovations in the export regressions).
  • One of their major findings is that innovations are indeed endogenous and their exogenous treatment leads to largely downward-biased estimates of the impact of innovations on firm-level exports.

2.3 Contribution of this paper

  • This paper departs from the strategy adopted in previous micro-econometric work on the innovation-driven exports hypothesis in two important ways.
  • 1A smaller number of studies that employed the less preferable R&D expenditures as an indirect measure of innovations lacked to find such a positive impact (see Cassiman and Mart́ınez-Ros, 2004, for a survey).
  • 5 First, it explicitly distinguishes between product and process innovations in the analysis and, second, it accounts for their endogeneity by allowing for an endogenous selection of firms into product and process innovations.
  • In contrast to earlier work, the authors use matching techniques for multiple binary treatments – in their case, new product and/or process innovations versus no innovations at all – to account for self-selection of firms into either type of innovation.

3 Empirical framework

  • In the subsequent analysis the authors assume that, after controlling for a set of observable variables, treatment participation does not depend on treatment outcome.
  • Since their data set allows us to disentangle product innovation from process innovation – hence, there are two treatment indicators at the firm level –, the authors have to depart from the strategy typically applied in models with a simple binary treatment variable.
  • Neither of these studies considers the impact of these two modes of endogenous innovations on exports.
  • Estimates of the average treatment effects can be obtained as follows.

4 Data

  • The authors data are based on the Ifo Innovation Survey that is conducted annually by the Ifo Institute, covering more than 1,000 firms in Germany per year.
  • The survey asks about the structure of innovations at the firm level.
  • In particular, it collects information about process versus product innovation activities and about export status.
  • Furthermore, the survey explicitly covers questions relating to exogenous innovation impulses and obstacles as well as other firm-level characteristics.
  • Beyond that, there is an industry indicator that allows us to link industry characteristics to the micro-level data.

4.1 Dependent variables

  • Regarding the dependent variables, the database provides information on whether a firm has exported and applied new product innovations or process innovations over the last six months or not.
  • In the year t the authors have introduced (or started but not yet finished) new product innovations.
  • First, 80.00 percent of the firms in their sample conduct exports.

4.2 Independent variables

  • Beyond the information for the dependent variables in their analysis, the survey asks about a set of incentives/impulses and obstables/impediments to innovation.
  • Of those, in their empirical model, only the following four impediments exert a significant impact on a firm’s probability to innovate: lacking own capital; lacking external capital; long amortization period; imperfect opportunities to cooperate with public or academic institutions.
  • In addition to these firm-level determinants the authors use characteristics that vary across NACE 2-digit industries published by EUROSTAT (NewCronos Database).
  • By way of contrast, the higher the weighted foreign wage costs are relative to foreign output, the lower the authors expect the competitive pressure for German producers to be ceteris paribus.
  • Table 2 summarizes mean and standard deviation of all covariates.

5 Estimation results

  • Table 3 presents the results of a multinomial logit model (assuming a logistic cumulative density function, respectively) determining a representative firm’s choice of product and/or process innovation.
  • This type of matching requires that the matched control units exhibit a propensity score that differs by not more than the radius from the propensity score of the treated unit they are matched onto.
  • In the table, the authors report estimates of all three treatment effects, θm,l, αm,l, and γm,l for all treatment pairs m and l and their standard errors.
  • The authors results indicate that the analytical standard errors are slightly more conservative (i.e., smaller) than the bootstrapped ones.
  • Firms that conduct new product and process innovations (the treated – T in the first table column – receive (d, c)) exhibit a significantly higher export propensity than ones that neither do product nor process innovations (the matched controls – C in the second table column – receive (0, 0)).

6 Sensitivity analysis and discussion

  • The authors undertake several robustness checks to assess the sensitivity of their findings.
  • The latter ensures that the authors estimate the impact of innovation on export propensity from a comparison of treated firms with untreated ones where the export status in the past was the same between the treated and the untreated.
  • Across the board, neither changing the radius nor the matching estimator (nearest neighbor or alternative kernel matching estimators with different bandwidths instead of radius matching) affects their conclusions from above, neither in qualitative nor in quantitative terms.
  • T denotes the treatment, C the control group.

7 Conclusions

  • The authors goal in this paper was to provide novel empirical insights in the role of product versus process innovation on export propensity at the firm level.
  • Either of these modes of innovation has been hypothesized to affect firm-level productivity in previous theoretical work.
  • Economic theory suggests that firms do not undertake innovations at random, neither product nor process innovations.
  • Viewing innovations as a ’treatment’, this lends support to an endogenous treatment approach to innovations and export propensity.
  • The largest estimated self-selection bias in the data amounted to more than 200 percent, depending on the mode of innovations (product and/or process innovation).

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ENDOGENOUS PRODUCT VERSUS PROCESS
INNOVATION AND A FIRM’S PROPENSITY
TO EXPORT
SASCHA O. BECKER
PETER H. EGGER
CESIFO WORKING PAPER NO. 1906
CATEGORY 9: INDUSTRIAL ORGANISATION
F
EBRUARY 2007
An electronic version of the paper may be downloaded
•
from the SSRN website: www.SSRN.com
•
from the RePEc website: www.RePEc.org
•
from the CESifo website: Twww.CESifo-group.deT
CESifo Working Paper No. 1906
ENDOGENOUS PRODUCT VERSUS PROCESS
INNOVATION AND A FIRM’S PROPENSITY
TO EXPORT
Abstract
This paper provides an empirical analysis of the effects of new product versus process
innovations on export propensity at the firm level. Product innovation is a key factor for
successful market entry in models of creative destruction and Schumpeterian growth. Process
innovation helps securing a firm’s market position given the characteristics of its product
supply. Both modes of innovation are expected to raise a firm’s propensity to export.
According to new trade theory, we conjecture that product innovation is relatively more
important in that regard. We investigate these hypotheses in a rich survey panel data set with
information about new innovations of either type. With a set of indicators regarding
innovation motives and impediments and continuous variables at the firm and industry level
at hand, we may determine the probability of launching new innovations and their impact on
export propensity at the firm level through a double treatment approach.
JEL Code: F1, O3, L1.
Keywords: product innovation, process innovation, propensity to export, multiple treatment
effects estimation.
Sascha O. Becker
Center for Economic Studies and CESifo
at the University of Munich
Schackstr. 4
80539 Munich
Germany
sbecker@lmu.de
Peter Egger
Ifo Institute for Economic Research
at the University of Munich
Poschingerstr. 5
81679 Munich
Germany
egger@ifo.de
December 4, 2006
We would like to thank the participants at the workshop Globalization Effects on Firms and
Workers at the University of Nottingham, November 2006, for comments on an earlier draft.
In particular, we are indebted in Zhihong Yu for helpful suggestions.
1 Introduction
Research on the role of innovation on economic outcome has for long been
at the heart of three different fields of the profession: macro-economics, in-
ternational economics, and industrial economics. Two central assumptions
can be thought of unifying these literatures, namely that innovation is en-
dogenous at the firm-level, and it is undertaken for the sake of distinguishing
products from competitors (horizontally or qualitatively) thereby securing
a firm’s market position against its rivals. We may associate innovation of
that kind with what we will refer to as product innovation. While macro and
trade economics tend to think of firm-level productivity as being determined
by nature or even drawn from a lottery, there is a well-established literature
in industrial organization that suggests that endogenous productivity gains
are possible through process innovation.
Overall, product characteristics and high productivity are now unde r-
stood as the corner stones for firms to sustain competition on the domestic
but even more so on global markets. Accordingly, we hypothesize that there
is a distinct role to play for product and and process innovations. Yet, their
distinct impact on domestic and foreign market penetration is hitherto the
target of only small bodies of theoretical and empirical work. To a large
extent, product and/or process characteristics and the corresponding modes
of innovation are typically viewed to be beyond a firm’s choice. The latter
is, however, largely at odds with both economic intuition and stylized facts.
This paper aims at contributing to previous empirical work on innovation
and exports by distinguishing between the effects of product and process
innovation on firm-level export propensity, and, at the same time, by taking
full account of either kind of innovation’s endogeneity.
The remainder of the paper is organized as follows. The next section
provides an overview of earlier theoretical and empirical work on innovation
to motivate determinants of innovations and derive hypotheses about their
consequences for productivity and export propensity. Section 3 elaborates on
the empirical framework for estimating the impact of two endogenous modes
of innovation on export propensity. Section 4 summarizes the main features
of our survey data. The empirical findings are presented in Section 5, they
are discussed and their sensitivity is investigated in Section 6, and the last
section concludes with a summary of the central findings.
2
2 Previous research and the contribution of
this paper
In the subsequent discussion of previous, innovation-related economic work,
it is useful to distinguish between theoretical and empirical research on the
issue.
2.1 Economic theory on innovation
There is a sizeable body of theoretical work that elaborates on the deter-
minants of innovation and their consequences for productivity and economic
growth and, to a lesser extent, for exports.
Macro-economists stress the importance of innovation in new products
as a prerequisite for economic growth. As indicated before, innovation is
endogenous itself and firms innovate more likely in large economies (where
fixed costs can be covered more easily), if the (exogenous) productivity in
research labs is high, product markets are competitive, and if consumers value
a large variety and/or a high quality of available products (see Grossman
and Helpman, 1991, chapters 3 and 4). Implicitly, most of the related studies
confine their interest to product innovation. Only recently, macro-economists
explore the potential differences between product and process innovations for
income, focusing on heterogeneous agents and technological unemployment
(Foellmi and Zweim¨uller, 2005). One key finding in the latter branch of
work is that pro ce ss innovation may lead to technological unemployment
in the short-to-medium run which may be offset by product innovation in
the long-run. While both process and product innovation spur aggregate
income, product innovation is preferable by avoiding the adverse effects of
technological unemployment.
International economic theory spots the role of product innovation for
trade in open economy growth models (Dollar, 1986; Jensen and Thursby,
1987; Grossman and Helpman, 1989, 1990, 1991, chapters 9-11; Segerstrom,
Anant, and Dinopoulos, 1990). As in closed-economy models of endogenous
growth, market size, the pro ductivity of research labs, consumer preferences
favoring a larger variety and/or a higher quality of products, and product
market competition are key determinants of innovation. An economy’s open-
ness to trade additionally fosters product market competition and, hence,
creates an incentive for a firm to innovate. In turn, innovation is a prereq-
3
uisite for firms to gain access to foreign consumer bases via exports. The
latter establishes the hypothesis of innovation-driven exp orts. In recent dy-
namic models with firms that exhibit heterogeneous productivity levels and,
hence, heterogeneous marginal production costs (Jovanovich, 1982; Hopen-
hayn, 1992; Melitz, 2003; Grossman, Helpman, and Szeidl, 2006) investment
in firm-specific assets leads to a sele ction of firms: the least productive ones
do not participate at the market at all and the most productive ones sup-
ply consumers not only at home but also abroad (through exports), while
those with an intermediate productivity only face demand from domestic
consumers. There, investment in firm-specific assets (to be associated with
product innovation, see Spence, 1984) and a high corresponding outcome
(i.e., a high total factor productivity) are the key determinants of a firm’s
export propensity.
Research in industrial economics provided pioneering results on the role
of marginal cost-reducing innovations (i.e., expenditures for research and
development for the sake of process innovation) in international oligopoly
models more than two decades ago (Spencer and Brander, 1983). A higher
investment in such process innovations increases a firm’s domestic and foreign
output. However, this eventually leads to an excessive amount of innovations
of that kind. The equilibrium level of (process) innovation expenditures in-
creases with domestic and foreign market size, and it declines in the level
of trade costs and the degree of product market competition (i.e., the num-
ber of competitors in the market). Subsequent research established insights
in the relationship between process innovation and competitive pressure at
the local (Martin, 1993) and the global level (Baily and Gersbach, 1995).
More recently, an explicit treatment of product versus process innovations
and the role of competitive pressure has been delivered by Boone (2000). The
impact of product market competition on a firm’s product and process inno-
vations crucially depends on the firm’s efficiency relative to its competitors.
When assuming that the aggregate efficiency can be measured by the (inverse
of) average production costs, then, Boone’s (2000) analysis suggests that a
higher level of competitive pressure cannot increase product and process in-
novation at the same time. Rather, an increase in the competitive pressure
may increase the efficienc y of each surviving firm but lead to the exit of less
productive ones, which is associated with a decline in product innovation.
Overall, a positive impact of competitive pressure on process innovation is a
possible, yet not a necessary outcome.
4
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Frequently Asked Questions (6)
Q1. What are the contributions in this paper?

This paper provides an empirical analysis of the effects of new product versus process innovations on export propensity at the firm level. The authors investigate these hypotheses in a rich survey panel data set with information about new innovations of either type. 

(1)The expected average effect of treatment m relative to treatment l for a firm randomly selected from the group of firms participating in either m or l is defined asαm,l = E(Y m − Y l|S = m, l) = E(Y m|S = m, l) − E(Y l|S = m, l), (2)where S is the assignment indicator, defining whether a firm receives treatment m or l. 

The expected average effect of treatment m relative to treatment l for a firm drawn randomly from the population is defined asγm,l = E(Y m − Y l) = E(Y m) − E(Y l). 

For instance, for the effect (d, c) versus (0, 0), the pseudo-R2 before matching is 0.354, i.e., the covariates are relevant predictors in the overall sample. 

Since their data set allows us to disentangle product innovation from process innovation – hence, there are two treatment indicators at the firm level –, the authors have to depart from the strategy typically applied in models with a simple binary treatment variable. 

Cassiman and Mart́ınez-Ros (2004) focus on innovations as such and treat them as predetermined variables (hence, they use once-lagged instead of contemporaneous innovations in the export regressions).