no bar to firm dynamism. Firms in Thailand are also relatively innovative on these measures, while those in Indonesia and Malaysia have been relative laggards.

Ayyagari et al (2006) find several correlates of firm innovation in this sample of developing country firms. First, core innovation outcomes are higher among younger (more recently created) firms, larger firms and firms with high capacity utilization. Second, these broader measures of innovation are not closely related to per capita income, suggesting that, given favorable economic and institutional conditions, firms can be highly innovative in this broad sense in even the poorest economies. (As we show later, formal R&D and sophisticated innovations that lead to patents are different, rising sharply with per capita income). Third, there is a strong negative association between state ownership and innovation, but there is no discernable difference whether a firm is a domestic or foreign privately owned firm. Fourth, there is a strong association between innovation and most types of external financing (equity finance, local or foreign owned commercial bank loans, lease finance, investment funds, trade credits and funds from family and friends).<sup>4</sup> The study also finds a positive association between innovation and the extent of competition faced by firms.

**Table 2. Most Important Source of Technological Innovation – 2003 (% of Firms)**

||Cambodia|Indonesia|Malaysia|Philippines|Thailand|Average|
|---|---|---|---|---|---|---|
|Embodied in new machinery|42.1|48.7|49.9|43.0|33.1|43.4|
|Cooperation with clients|11.9|15.1|8.6|9.7|17.2|12.5|
|By hiring key personnel|14.5|17.9|11.4|14.2|3.0|12.2|
|Developed within the firm locally|16.1|4.7|7.2|8.3|19.4|11.1|
|Transferred from parent|6.0|2.7|11.0|4.3|11.8|7.2|
|Developed with supplier|1.6|7.0|5.2|5.0|7.2|5.2|
|Other|7.8|3.9|6.7|15.5|8.2|8.4|

Source: World Bank. Investment Climate Surveys. Malaysia is 2002, Thailand is 2004.

Finally the Bank’s Investment Climate Surveys also provide a view into the sources of knowledge that firms in these low and middle income economies use to make innovations. Table 2 shows that the single most important source of knowledge for firms in these East Asian economies (cited on average by over 40 percent) was technology embodied in new machinery or equipment (most of which can be assumed to be imported). The next two most cited sources of innovation – those developed in cooperation with client firms and hiring of key personnel were cited by 12-13 percent of firms, while innovations developed or adapted within the firm were cited by only 11-12 percent. These observations provide a good springboard for a more detailed inspection of the methods by which firms absorb knowledge from abroad.

# **_Technology Transfer through Imports_**

Exceptionally high levels of international trade are a common feature across most East Asian economies, providing a variety of potential channels for acquisition of knowledge. One is through the import of advanced capital equipment embodying new technologies that could either

> 4 The study uses instrumental variables to control for the obvious possibility of reverse causation – that external finance flows to more innovative firms – but finds that variable remains significant.

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