narrowly defined sectors; suggesting that policies that target the average firm--as was traditionally done in the past--may end up not having a relevant impact if the distributions of firm attributes and performance are significantly dispersed. While much policy attention has focused on innovation and productivity determinants that are external to the firm, such as competition policy or policy distortions in factor and product markets, few policy measures, if any, have sought to address one of the most important determinants of productivity: firm-level innovation activities. One reason for this knowledge gap has been due to a dearth of data at the firm level in the developing world that can inform policy makers. A key objective of this paper is to provide an empirical overview of firm-level innovation activities in the South Asia region - Bangladesh, India, Nepal, and Pakistan - and explore its causal links, when possible, to firmlevel productivity.

This paper is structured as follows: Section 2 describes the main findings in the literature. Section 3 talks about the main challenges of measuring innovation and the data used for this paper. Section 4 describes the main patterns in terms of investments in knowledge capital. Section 5 explores innovation patterns. Section 6 examines the links between innovation and productivity. The final section presents the main conclusions.

# 2. What Does the Literature Say about the Causal Effects of Innovation on Productivity?

For several years, policy makers and researchers have emphasized the role of factor accumulation as a way to foster economic progress. However, after the last two decades of empirical research on economic growth, economists have concluded that total factor productivity (TFP)--a measure of improvements in efficiency and technological progress--explains the bulk of cross-country differences in both the level and growth rate of per capita GDP (Easterly and Levine, 2001). Since then, several empirical attempts have been conducted to identify the sources of productivity growth at the firm level. Within this literature, exploring the causal links between innovation and productivity has become a key priority for both policy makers and academics, as innovation can affect firm-level productivity through several channels. For example, process innovation increases efficiency in the use of intermediate inputs and factors of production; product innovation creates learning-by-doing effects that make firms more competitive; while organizational innovation encourages the reallocation of inputs and factors of production across activities within firms, enhancing production efficiency.

Recently, two well-known surveys conducted by Hall (2011) and Mohnen and Hall (2013) provide a comprehensive overview of the channels and effects of innovation on firm-level productivity. Their surveys pay special attention to the results of papers that have been trying to address the causality and endogeneity problems of innovation inputs and outputs in a convincing way. Therefore, their reviews focus mainly on papers that have been using the Crepon, Duguet, and Mairesse (1988) (CDM) model. Two different empirical strategies have been employed in the literature when estimating this model. One approach uses Asymptotic-Least-Squares, which embodies the joint estimation of the main equations of the model. The other approach estimates a sequential model, where predicted values of endogenous variables in the first stage are included in the estimation of the second- and third-stage equations. A main conclusion from Hall et al. (2009) and Musolesi and Huiban (2010), who compare the results from both methods, is that there are not significant differences in the impact of innovation on productivity as long as endogeneity and selection are properly treated.

The literature has used continuous and dichotomous innovation variables to estimate their effects on productivity. According to Mohnen and Hall (2013), results from 12 papers, most of them from developed economies, suggest that the elasticity of firm-level productivity with respect to the intensity of product 3