metadata: authors: 0: author: Almeida, Rita
1: author: Fernandes, Ana Margarida
count: World
docna: 0: docna: Openness and technological innovations in
            developing countries : evidence from firm-level surveys
docty: Policy Research Working Paper
subtopic: Adaptation to Climate Change,Trade Policy,International Trade and Trade Rules,Access to Finance
teratopic: Industry,Science and Technology Development,Information and Communication Technologies,International Economics and Trade
abstracts: cdata!: The authors analyze the role of
            international technological diffusion for firm-level
            technological innovations in several developing countries.
            Their findings show that, after controlling for firm,
            industry, and country characteristics, exporting and
            importing activities are important channels for the
            diffusion of technology. They also find evidence that the
            majority of foreign-owned firms are significantly less
            likely to engage in technological innovations than minority
            foreign-owned firms or domestic-owned firms. The authors
            interpret this finding as evidence that the technology
            transferred from multinational parents to majority-owned
            subsidiaries is more mature than that transferred to
            minority-owned subsidiaries. This finding supports the idea
            that equity joint ventures maximize technology transfers to
            local firms.
repnme: repnme: Openness and technological innovations in
            developing countries : evidence from firm-level surveys
display_title: Openness and technological
            innovations in developing countries : evidence from
            firm-level surveys
listing_relative_url: /research/2006/08/6969646/openness-technological-innovations-developing-countries-evidence-firm-level-surveys
topicv3: Innovation, Technology Transfer and
            Diffusion m1326019 1084,Trade m1326924 698,Access to Finance m1327464 1249,Climate Change Adaptation m1327767 574,Trade and FDI m1504264 2556
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Industry,Science and Technology Development,Information and Communication Technologies,International Economics and Trade
no_of_pages: 35
model_extractions: WPS3985

# Openness and Technological Innovations in Developing Countries

# ∗ Evidence from Firm-Level Surveys

Rita Almeida The World Bank and Ana Margarida Fernandes The World Bank

### Abstract

This paper analyzes the role of international technological diffusion for firm-level technological innovations in several developing countries. Our findings show that, after controlling for firm, industry, and country characteristics, exporting and importing activities are important channels for the diffusion of technology. We also find evidence that majority foreign-owned firms are significantly less likely to engage in technological innovations than minority foreign-owned firms or domestic-owned firms. We interpret this finding as evidence that the technology transferred from multinational parents to majority-owned subsidiaries is more mature than that transferred to minority-owned subsidiaries. This finding supports the idea that equity joint ventures maximize technology transfers to local firms.

Keywords: Innovation, Technology Adoption, Exports, Imports, Foreign Ownership, Firm Level Data.

JEL Classification codes: F1, F2, O3.

## World Bank Policy Research Working Paper 3985, August 2006

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at_ _<u>http://econ.worldbank.org.</u>_

> ∗ We thank Robin Burgess, Alberto Salvo, Luis Serven and Jim Tybout and participants at the 2006 International Industrial Organization Conference for their suggestions. Please address correspondence to Ana M. Fernandes, The World Bank, 1818 H Street, NW, Washington DC 20433. Phone: 202-473-3983. Fax: 202-522-3518. E-mail: afernandes@worldbank.org.
# 1. Introduction

Growth theory has for long established that improvements in technology have an effect on long-run growth (Romer, 1990; Aghion and Howitt, 1998). Moreover, differences in technology have been found to be an important determinant of differences in total factor productivity across countries (Hall and Jones, 1999; Klenow and Rodriguez-Clare, 1997) and across fi rms (Griliches, 1998; Parisi et al., 2006). While most fi rms improve their technology by simply imitating or adapting existing production techniques to local conditions, other fi rms are truly engaged in the creation of new technologies. Even though this is true for fi rms worldwide, this is particularly important in developing countries. There, the adoption of existing technologies from abroad can occur through the contacts with foreign partners, foreign suppliers and/or foreign clients or through the direct trade in technologies (e.g., licensing). Most empirical studies on the international diffusion of knowledge provide indirect evidence on the importance of different channels by documenting a link between trade or FDI and fi rm-level productivity. In this paper, we use fi rm-level data on the adoption of new technology in several developing countries to provide new evidence on the incentives of fi rms to adopt new technology and on the importance that trade and foreign direct investment (FDI) have as channels for the diffusion of technology.<sup>1</sup> New technologies can be transmitted across countries through different activities. Foreign direct investment is one possible channel. Multinational parents, endowed with a more advanced technology, usually transfer their knowledge and technology to their subsidiaries. However, there is some debate on the quality of the technology that is actually transferred from multinational parents. Throughout the world, many policies to attract FDI are based on the premise that joint ventures between foreign and domestic-owned fi rms are more fruitful than fully-owned foreign subsidiaries because they induce a greater technology transfer. This view is not consensual, though, as there is some evidence that multinational parents

> 1The international diffusion of technology to fi rms integrated into global markets may subsequently spill over to other domestic fi rms in the same region or industry not directly engaged in international activities. The latter could happen through demonstration effects, labor turnover, or reverse engineering. This paper will focus only on technology transfers to fi rms integrated into global markets, not on spillovers.

2
have an incentive to transfer older technologies to their subsidiaries in developing countries than to those in developed countries to avoid the risk of expropriation (Mans fi eld and Romeo, 1980). Others fi nd that technology transfers from parent fi rms to fully-owned subsidiaries are higher than those to minority-owned subsidiaries (Ramachandran, 1993). Alternatively, the international transmission of technology can occur through trade. If new knowledge is embodied in imported capital goods or intermediate inputs, we would expect importers to be more innovative than fi rms that source only in the domestic market. Importers can improve their technology by incorporating in their production processes these state-of-theart inputs or machinery, which may not be available domestically (Grossman and Helpman, 1991). Similarly, exporters can learn about new technologies or products through their interaction with more knowledgeable foreign buyers in external markets. Alternatively, they may be exposed to more competitive markets and hence be forced to improve their technology frequently. If the exposure to export markets is indeed a channel promoting innovations, we would expect exporters to be more likely to adopt new technologies than fi rms selling exclusively to the domestic market. Finally, fi rms can engage in the direct trade of knowledge, through technological licensing agreements, to acquire new technology. These channels are not necessarily used in isolation. For example, the use of licensing and FDI are often complementary channels for the international transmission of technology.

Perhaps the biggest difficulty in the analysis of the international transmission of technology is to gather good indicators on the adoption of new technology. How one exactly de fi nes a technological innovation depends on the speci fi cities of each fi rm and its production process. Most of the empirical work using micro data uses information on fi rm-level research and development (R&D) expenditures or the number of patented technologies.<sup>2</sup> However, the R&D activities of the fi rm are only one type of research inputs in the process of generating new technologies and they do not necessarily lead to a successful and applicable new technology. Moreover, the propensity to patent varies widely across industries and is likely to be more important for the creation of new knowledge than for the adoption and adaptation

> 2One exception is Comin et al. (2006) that use a cross-country dataset on the adoption of speci fi c technologies.

3
of existing knowledge. The fi rm-level dataset we use allows us to construct a broad measure of technological innovation, which includes the creation of new production processes but also the adoption and adaptation of existing technologies to local conditions. In particular, the survey collects information on whether fi rms introduced recently new technology that substantially changed their main process of production. This measure of technological innovation is more likely to re fl ect advances of the fi rm towards the country’s knowledge frontier, rather than movements of the technological frontier itself. This is arguably a better measure to study technological innovations and their international diffusion, especially in the context of developing countries. Also important to our analysis, the survey collects very detailed information on fi rm characteristics, including their export and import activities and foreign ownership.

Using this fi rm-level dataset covering 43 developing countries, we will analyze the following questions. First, which fi rms have a larger incentive to engage in technological innovations? Second, is the fi rm’s integration into global markets an important channel for the acquisition of new technologies? Which speci fi c channels for the transfer of new technology are explored by those fi rms that engage in trade or have some foreign ownership?

Our paper relates to two strands of literature. First, it relates to the large micro literature that studies the determinants of innovation, which originated in the work by Schumpeter (1942) (e.g., Cohen and Levin, 1989; Cohen, 1995; Aghion et al., 2005). Particularly related to our work is Criscuolo et al. (2005). Like us they explore fi rm-level data to compute a broad measure of innovation and relate the fi rm’s propensity to innovate with its integration into global markets. Their fi ndings show that those UK. fi rms that are more integrated into global markets are more likely to innovate, but that most of the difference is explained by the number of scientists and researchers used. Vishwasrao and Bosshardt (2001) also fi nd that foreign-owned fi rms in India are more likely to adopt new technology than domestic-owned rms.<sup>3</sup> Second, our paper relates to the vast literature on the effects of integration into global

> 3The cross-country evidence also points to a positive correlation between trade openness and the speed at which countries adopt new technologies (Comin and Hobijn, 2004) or invest in R&D (Lederman and Maloney, 2003).

4
markets on productivity (Tybout, 2000; Keller, 2005). One possible channel through which the integration into global markets results in higher productivity is through technological transfers and the resulting access to a wider knowledge base (e.g., Grossman and Helpman, 1991). While most empirical studies look at the effect of the participation in international activities on fi rm-level productivity, there is little evidence on the actual effect that these activities have on fi rm-level technological innovations. The evidence available suggests that fi rm level productivity is higher for those fi rms integrated into global markets through exports, FDI, or imports of intermediate inputs. In the literature studying the link between fi rm performance and exports there is strong evidence of self-selection of the most productive fi rms into exporting (Clerides et al., 1998; Bernard and Jensen, 1999) but there is also evidence of a learning-by-exporting effect (Alvarez and Lopez, 2005; Fernandes and Isgut, 2006). The latter is consistent with the contacts of exporting fi rms with more knowledgeable foreign buyers generating an increased access to (or demand for) better technologies. Also, fi rms may be forced to frequently improve their technological capabilities in order to face strong competition in export markets. There is also evidence that fi rms with FDI tend to be more productive than domestic fi rms (e.g., Djankov and Hoekman, 2000; Arnold and Javorcik, 2005).<sup>4</sup> Finally, there is also some evidence that imports of intermediate inputs are positively correlated with fi rm and aggregate productivity (Kasahara and Rodrigue, 2005; Coe et al., 1997; Lumenga-Neso et al., 2005).<sup>5</sup> The main fi ndings of our paper can be summarized as follows. First, we fi nd that there is a lot of heterogeneity at the fi rm-level in the acquisition of new technology, even after controlling for differences across countries and industries (accounting for approximately 13% of the total variation). Part of this heterogeneity is explained by the size of the fi rm and its human capital. For example, medium and large fi rms are 13 and 18 percentage points more likely to adopt new technology than micro fi rms, respectively. Second, we fi nd a very

> 4Arnold and Javorcik (2005) fi nd that a fi rm’s total factor productivity increases signi fi cantly following its acquisition by foreign multinationals in Indonesia.

> 5Coe et al. (1997) and Lumenga-Neso et al. (2005) fi nd that foreign knowledge embodied in imported inputs (from countries with large R&D stocks) has a positive effect on aggregate total factor productivity in developing countries.

5
strong positive correlation between trade and technological innovation. All else constant, importers and exporters are 4.3 and 7.3 percentage points more likely to report technological innovations than fi rms that do not engage in each of these activities, respectively. While it is possible that these estimates are biased upwards due to the selection of the more competitive fi rms (and hence more prone to adopt new technologies) into these activities, in our sample this problem does not seem to be too severe for exports. Firms that started exporting more than 10 years prior to the survey are still 4.2 percentage points more likely to report technological innovations than fi rms that do not export. Third, we fi nd strong evidence that in low-tech industries majority foreign-owned fi rms are signi fi cantly less likely to engage in technological innovations than domestic-owned fi rms.<sup>6</sup> This fi nding holds when we compare fi rms with similar managerial education and access to fi nance operating in the same region and industry. Moreover, majority foreign-owned fi rms are less likely to engage in technological innovation than minority foreign-owned fi rms. We interpret this fi nding as evidence that the technology transferred from multinational parents to majority-owned subsidiaries is more mature than the technology transferred to minority-owned subsidiaries. This provides some support to the idea that equity joint ventures maximize the quality of the technology transferred to local fi rms. Around the world, policies to attract FDI have been based on this presumption although the little empirical evidence available supports the contrary (Mans fi eld and Romeo, 1980; Ramachandran, 1993; Javorcik, 2006).

The paper proceeds as follows. Section 2 describes the data and provides summary statistics. Section 3.1 describes our main fi ndings on the pro fi le of fi rms that engage in technological innovations and the importance of the different channels for the international transfer of knowledge. Section 3.2 tests the robustness of the results and Section 4 concludes.

> 6To the extent that foreigners select the best-performing fi rms and we are unable to fully account for this through our fi rm, industry and country controls, our negative point estimate could still be biased upwards.

6
# 2. Data

We use a fi rm-level dataset collected by the World Bank across 43 developing countries (Investment Climate Surveys).<sup>7</sup> The surveys were conducted between 2002 and 2005 and the samples were designed to be representative of the population of fi rms according to their industry and location within each country. Although only one wave of data is available for each country, the information available in the survey has several advantages for analyzing technological innovations. First, it is based on a common questionnaire across a large set of countries, which yields comparable information on several fi rm-level variables. Among others, the survey collects information on whether the fi rm recently adopted new technology, the main channels used to acquire technological innovations, its ownership structure, age, size, human capital composition, and whether it participates in international trade. The survey also collects information on the fi rm’s R&D activities and technology licensing. Table A.1 de fi nes in detail all the variables used in the analysis and Table A.2 reports the summary statistics. The fi nal sample includes 17, 723 fi rms distributed across a wide set of manufacturing industries - auto and auto components, beverages, chemicals, electronics, food, garments, leather, metals and machinery, non-metallic and plastic materials, paper, textiles, wood and furniture - in 43 countries in Africa, Asia, Eastern Europe, and Latin America.<sup>8</sup> Second, the survey allows us to use a broad de fi nition for technological innovation. Speci fi cally, we de fi ne technological innovation as a dummy variable equal to one if a fi rm reports having introduced new technology that substantially changed the way in which its main product

> 7The Investment Climate Surveys were conducted in 68 developing countries. We use data for only 43 countries, due to the lack of information on the main variables of interest for the remaining countries. We focus the analysis on manufacturing fi rms only. The information collected in the surveys is based on a 1.5-2 hours interview with the fi rm manager. Detailed information on the surveys can be obtained at: http://iresearch.worldbank.org/ics/jsp/index.jsp. In what follows, we will refer to fi rms as being the unit of analysis but the unit of data collection was actually an establishment or plant.

> 8The countries included in the dataset are Albania (2005), Armenia (2005), Belarus(2005), Bosnia and Herzegovina (2005) Brazil (2003), Bulgaria (2005), Chile (2004), China (2003), Croatia (2005), Czech Republic (2005), Ecuador (2003), Egypt (2004), El Salvador (2003), Estonia (2005), Georgia (2005), Guatemala (2003), Honduras (2003), Hungary (2005), Indonesia (2003), Kazakhstan (2005), Kyrgyzstan (2005), Latvia (2005), Lithuania (2005), Madagascar (2005), Malaysia (2003), Moldova (2005), Nicaragua (2003), Philippines (2003), Poland (2005), Romania (2005), Russia (2005), Serbia and Montenegro (2005), Slovakia (2005), Slovenia (2005), South Africa (2003), Tajikistan (2005), Thailand (2004), Turkey (2005), Ukraine (2005), Uzbekistan (2005), Vietnam (2005), and Zambia (2002). The year in parentheses indicates when the survey was conducted in each country.

7
is produced in the three years prior to the survey.<sup>9</sup> De fi ning a technological innovation in this way is particularly important in the context of developing countries to understand how fi rms catch-up to the world technological frontier.<sup>10</sup> This variable will capture not only the creation of new knowledge but also the adoption and adaptation of production processes, which although new to the fi rm, may not be new to the country nor to the world. In our sample, 48% of fi rms report having conducted R&D activities and, of these, 63.4% report having adopted new technology.<sup>11</sup> The fact that 25% of the fi rms in our sample report having adopted new technology without having conducted any R&D activities reinforces the importance of using alternative measures of technological innovation. Third, the survey collects detailed information on the major channels used by fi rms to acquire technological innovations. On average, 71% of fi rms in the sample report that their new technology was either embodied in new machinery, developed/adapted within the fi rm, transferred from the parent company, or developed by key personnel or by consultants. A lower share of fi rms (32%) reports that technology was acquired or developed in coordination with supplier/clients (including licensing or turnkey operations from domestic or international sources, developed in cooperation with client fi rms, or developed with equipment and machinery suppliers) and only 13% of fi rms report that technology was developed in coordination with other institutions (including universities and public institutions, business or industry associations, trade fairs or study groups).

# One shortcoming of our data is that it captures only the intensive margin of technological

> 9There is some arbitrariness in this de fi nition which could introduce measurement error in the dependent variable in the regressions in Section 3. If this measurement error is classic, this is not a problem. However, biases could result if the measurement error is systematically related to fi rm characteristics. For example, if smaller fi rms report more often that they change their technology, the estimated coefficient for small fi rms would be biased downwards.

10 The survey also collects information on whether the fi rm developed new major product line(s) or upgraded existing product line(s) in the three years prior to the survey. However, since the focus of this paper is on technological innovations and the channels for technology diffusion, we do not focus on product innovations. Nevertheless, in Table A.4, we estimate our main speci fi cations using as a dependent variable a dummy variable equal to one if the fi rm engages in technological innovation or product innovation. Those results provide evidence on the importance of different channels for international knowledge diffusion for the fi rm’s propensity to innovate.

> 11The fi nding that almost half of the fi rms in our sample conduct some R&D activities suggests that managers very likely consider as R&D those activities that relate to the adaptation of technologies to local conditions (in contrast to considering only frontier research activities as R&D).

8
innovation, but does not have information on the extensive margin. This contrasts with the information available in the Community Innovation Surveys (CIS) recently conducted in most European countries by the OECD (e.g., OECD, 1992; Evangelista et al., 1997; Criscuolo et al., 2005; Mohnen et al., 2006). Nevertheless, relative to the CIS datasets, our data has the advantage of collecting information on fi rm characteristics for all the fi rms in the sample while in most countries CIS datasets collect that information only for fi rms that innovate.<sup>12</sup> Table 1 reports the average share of fi rms engaged in technological innovations across continents and industries and Figure 1 shows this average for each country in our sample. The evidence shows that a large share of fi rms report being engaged in technological innovations (56.1%) but also that there is signi fi cant heterogeneity across countries.<sup>13</sup> Egypt and Uzbekistan show up as the countries with the lowest frequency of technological innovations while Thailand and Brazil report the highest frequencies in our sample. Table 1 also shows substantial heterogeneity in the degree of technological innovation across industries. Traditional industries tend to have fewer innovative fi rms while high-tech industries tend to have more. The most innovative industries are electronics and auto-parts while the least innovative are paper and food.<sup>14</sup> To assess whether our innovation measure is economically meaningful, we analyze its correlation with relevant fi rm outcomes. Figure 2 plots the kernel density of labor produc-

> 12One exception is the CIS dataset for the UK, used by Cricuolo et al. (2005), which collects information on fi rm characteristics for all fi rms, regardless of their innovation status.

> 13Firms in our sample are more likely to engage in product innovation (68.8%) than in technological innovation (56.1%). This fi nding holds across industries and countries, with the exceptions of electronics and auto-parts as well as China, Malaysia, and Thailand. But different fi rms engage in the two types of innovation since the average propensity to engage in technological or product innovation is 77.6%. The average share of fi rms that engage in both types of innovation is 47.5%, while the probability of engaging in product innovation for fi rms that have also introduced technological innovations is 84.7%. The latter shows that technological innovations are likely to result in changes in product design and quality and thus new or improved products. However, engaging in technological innovations does not result in product innovation with certainty.

> 14Using the CIS datasets for 10 countries, Evangelista et al. (1997) fi nd that the average propensity of European fi rms to introduce process (technological) or product innovations is 53%. The comparable average in our sample is much higher, 78%. This difference holds even within industries. In European countries, the average propensity to innovate in the electronics (textiles) industry is 67% (33%), which compares with an average of 82% (77%) in our sample. The ranking of industries is very similar across the two samples. This difference in the propensity to innovate across the two samples can be explained by managers in developing countries being more likely to report small changes in technology or products as being an innovation than managers in developed countries.

9
tivity (measured as value added per employee) for fi rms that are engaged in technological innovations and for fi rms that are not. Figure 2a reports evidence for the country with the lowest frequency of technological innovations, Egypt, while Figure 2b reports evidence for the country with the highest frequency of technological innovations, Brazil. Both fi gures show that fi rms that adopt new technology have higher labor productivity than those that do not. This positive correlation suggests that our technological innovation measure captures an economically important activity.

Table 2 reports the average frequency of technological innovations for different types of fi rms. While only 54% of domestic-owned fi rms report having adopted new technology, foreign-owned fi rms are substantially more innovative in this respect, particularly those with minority foreign ownership whose propensity to adopt new technology is 74.1%. Also, the share of fi rms reporting technological innovations is much higher for exporters (64.8%) and for importers (62.7%) than for the full sample.<sup>15</sup> These statistics suggest that trade and FDI are associated with more dynamic fi rms in developing countries. Note that fi rms integrated into global markets also report higher innovation inputs, measured by the propensity to engage in R&D activities. Hence, it is possible that their higher probability of technological innovation is simply explained by their higher probability of conducting R&D activities. Alternatively, there may be other important factors in fl uencing technological innovation such as the size of the fi rm.<sup>16</sup> This issue will be investigated in the next section.

We turn next to the differences across fi rms engaged in global activities in the channels used to acquire technological innovations. Table A.3 reports the results from probit regressions of each of the sources of technological innovations (shown as column headings) on the foreign ownership variables, and exporter and importer status, controlling for industry fi xed effects and for countries’ per capita GDP in 1995. For minority and majority foreign-owned fi rms, transfers from the parent company are signi fi cantly more important as

> 15The higher propensity to adopt new technology of importers and exporters is veri fi ed also within industries and countries.

> 16Table 2 also reports the association between size categories (based on total employment) and technological innovations. Large fi rms are substantially more prone to adopt new technologies than smaller fi rms and the relationship is monotonic.

10
a source of technological innovations than for other fi rms. The development in cooperation with client fi rms is a signi fi cantly more important source of technological innovations for minority foreign-owned fi rms than for domestic-owned fi rms, while the reverse is true for majority foreign-owned fi rms. Moreover, for majority foreign-owned fi rms the acquisition of technological innovations from any of the external institutions is signi fi cantly less important than for other fi rms. For exporters, development in cooperation with client fi rms and equipment or machinery suppliers is a signi fi cantly more important source of technological innovations, but so is the development and adaptation within the fi rm. Finally, for importers there is a signi fi cantly more important role of technology embodied in new machinery and equipment relative to non-importers and a less important role of technology development with client rms.

In sum, the fi ndings in this section show interesting patterns in technological innovations and their sources for fi rms that are integrated into global markets. The rest of the paper tests whether the bivariate correlations found so far resist more rigorous econometric estimation.

# 3. Empirical Findings

## 3.1. Main Estimates

Our empirical framework considers pro fi t maximizing fi rms deciding whether or not to engage in technological innovation. A fi rm decides to innovate if this decision is expected to increase its pro fi ts or, in other words, if the bene fi ts from this decision are larger than the costs. Let π<sup>∗</sup> ijc<sup>betheprofitsofafirm iinindustryjincountryc.Then,weassumethat:</sup> where Innovijc is a dummy variable that equals one if fi rm i reports engaging in technological innovation. Since π<sup>∗</sup> ijc<sup>is unobserved, Equation (3.1) cannot be estimated directly.Therefore,</sup> we assume that π<sup>∗</sup> ijc<sup>is a function offirm, industry, and country characteristics.In particular,</sup> we assume a linear form so that π<sup>∗</sup> ijc<sup>=βXijc+Ij+γIc+εijc,whereXijcisavector</sup> of fi rm characteristics, Ij are industry fi xed effects, Ic are country-level variables, and εijc 11
captures unobserved fi rm, industry, and country characteristics. For this functional form, the probability that fi rm i innovates is given by: Assuming that εijc are normally distributed, we can estimate Equation (3.2) by maximum likelihood (probit). Standard errors are clustered to allow for the possibility that the εijc are correlated across fi rms within country-industry cells. Table 3 reports the results from estimating different versions of Equation (3.2) which add progressively fi rm characteristics to Xijc. For each regressor, we report the marginal effects on the propensity to engage in technological innovation, at mean values. We include in all speci fi cations industry fi xed effects to control for differences in the production technology, product demand, and market competition across industries that could facilitate or require a fi rm to adopt new technology more frequently (Cohen and Levin, 1989).<sup>17</sup> Column (1) reports that within industries, foreign-owned fi rms are more likely to engage in technological innovations than domestic-owned fi rms. In column (2), when we control for export and importing activities, there is still evidence that minority foreign-owned fi rms are signi fi cantly more likely to innovate but majority foreign-owned fi rms are now as likely as domestic-owned fi rms to adopt new technology. Moreover, within industries, exporters and importers are signi fi cantly more likely to adopt new technology than fi rms that do not trade. Since globally-integrated fi rms may be larger or have better workers than other fi rms and these advantages may be driving their higher propensity to adopt new technology, columns (3) and (4) include in the regression fi rm age, size, a public ownership dummy, and proxies for the quality of the fi rm’s human capital. The main fi ndings of a strong positive association between minority foreign ownership, exports, and imports on the one hand, and the propensity to adopt new technology on the other hand are maintained. Controlling for these variables, majority foreign-owned fi rms are now signi fi cantly less likely to adopt new

> 17There could also be differences across industries in what is de fi ned as a technological innovation. For example, in an industry where there is continuous change, a small technological change may not be considered an innovation.

12
technology than minority foreign-owned or domestic-owned fi rms.

Countries with a more favorable environment for innovation may also offer better export and import opportunities, receive more FDI, and have a more educated workforce. Since several policy and institutional dimensions could be relevant for international activities and could also affect innovation, we control for countries’ per capita GDP in 1995 and for country fi xed effects in columns (5) and (6), respectively.<sup>18</sup> The relationship between fi rm-level openness and technological innovations remains robust and the magnitude of the effects does not change much relative to the previous columns. The magnitude of the effects in our preferred speci fi cation (column (6)) is economically signi fi cant. Firms that export are 4.3 percentage points more likely to innovate than fi rms selling only to the domestic market while importers are 7.6 percentage points more likely to innovate than fi rms using only domestic suppliers.<sup>19</sup> Firms with a minority foreign participation are 6.1 percentage points more likely, while majority foreign-owned fi rms are 4.4 percentage points less likely to adopt new technology than domestic-owned fi rms.

The fi ndings in this table also show other interesting patterns. First, there is a negative relation between the propensity to engage in technological innovations and the age of the fi rm. This fi nding could be the result of some “creative destruction” as young fi rms are more innovative and dynamic than older fi rms with weaker learning possibilities (Schumpeter, 1942).<sup>20</sup> Second, larger fi rms are more likely to engage in technological innovations. In our preferred speci fi cation, in column (6), small, medium, and large fi rms are 6.4, 13.3, and 18.3 percentage points more likely to report technological innovations than micro fi rms, respectively. This size advantage can be the result of economies of scale in the adaptation or development of new technology (e.g., Cohen and Klepper, 1996) or it can re fl ect the greater capacity of large fi rms to fi nance innovation projects in the presence of imperfect fi nancial

> 18We include past GDP per capita, since current GDP per capita could be correlated with omitted variables in our speci fi cation also affecting innovation.

> 19 Our fi ndings are robust to changing the de fi nition of exporters (importers) to those fi rms that export (import) more than 10% of their output (intermediate inputs). These results are available upon request. 20 Klepper (1996) develops a model that yields a negative relation between age and the propensity to innovate. To the extent that technological innovations improve the probability of survival, the negative point estimate reported in Table 3 would be an upper bound relative to the true effect of fi rm age on innovation (Audrestch, 1995).

13
markets.<sup>21</sup> Finally, the results in Table 3 show that the fi rm’s human capital - measured by the incidence of on-the-job training and the percentage of the workforce with more than secondary education - is positively related with the propensity to adopt new technology.<sup>22</sup> These results are in line with the idea that a more quali fi ed workforce improves the fi rm’s absorptive capability and reduces the costs of adopting or creating new technologies (Cohen and Levinthal, 1989). Table 3 also shows that public-owned fi rms are less likely to adopt new technology, although the effect is not statistically signi fi cant. This fi nding could re fl ect the fact that public-owned fi rms tend to operate in more protected markets and thus have smaller incentives to innovate.

In sum, the main results in this section suggest an important role of trade and FDI for technological innovations at the fi rm level. The technological advantage of exporters could be the result of their access to more and better knowledge through the interactions with foreign buyers or it could simply re fl ect a higher pressure to innovate driven by the strong competitive pressures felt in foreign markets.<sup>23</sup> Similarly, the technological advantages of importers could re fl ect a process of reverse engineering of higher quality foreign inputs. This mechanism would allow fi rms to learn about the embodied technological knowledge which may not be available domestically (e.g., Grossman and Helpman, 1991; Keller, 2005). Minority foreign-owned fi rms are also more likely than domestic-owned fi rms to adopt new technology while majority foreign-owned fi rms are less likely.<sup>24</sup> This evidence sheds some doubts on the dynamism imparted by the technology that multinational parents transfer to their fully-owned or majority-owned subsidiaries in developing countries. This fi nding could be suggesting that parent multinationals transfer more mature technologies less prone to

> 21Cohen (1995) also fi nds an innovation advantage for larger fi rms in developed countries. Cohen and Klepper (1996) develop a model where larger fi rms have more incentives to innovate since they face lower average fi xed (innovation) costs per unit of output.

> 22A positive correlation between innovation or technology adoption and human capital is documented at the aggregate level by Comin and Hobjn (2004), Lederman and Maloney (2003), and Keller (2005).

> 23Exporters may also bene fi t from scale economies in innovation due to their access to larger foreign markets. Hobday (1997) provides evidence for the electronics industry that the large size of export orders received by fi rms in Asian countries played an important role in encouraging them to undertake R&D.

> 24Our fi ndings seem to differ from those in Criscuolo et al. (2005) for the UK, where foreign-owned fi rms are more innovative (in the sense of being more likely to introduce new processes or products) and those in Vishwasrao and Bosshardt (2001) for India, where foreign-owned fi rms are more likely to adopt foreign technology than domestic-owned fi rms.

14
adaptations and improvements to their majority-owned subsidiaries than to their minorityowned subsidiaries.<sup>25</sup> Thus, our evidence provides some support to the idea that equity joint ventures transfer a more dynamic technology to local fi rms. This idea has been at the center of policies to attract FDI across many developing countries that favor joint ventures with local partners over majority foreign ownership. However, the evidence so far has been of stronger technology transfers to majority-owned subsidiaries (Mans fi eld and Romeo, 1980; Ramachandran, 1993; Javorcik, 2006).<sup>26</sup>

# 3.2. Robustness

Our fi ndings in Table 3 identify important associations between international technology diffusion through trade and FDI and fi rm-level technological innovations in developing countries. However, some of the estimates may be biased. First, if multinational parents tend to acquire the best - more innovative and productive - domestic fi rms, then the coefficients on foreign ownership could be biased upwards. This problem is particularly relevant for the coefficient on minority foreign ownership. Second, if technological innovations improve a fi rm’s ability to enter and remain in foreign markets or to buy from foreign suppliers, then our point estimates of the coefficients on exporter and importer status could also be biased upwards. Finally, it is possible that some unobserved variables, such as, e.g., managerial ability, that are correlated with the propensity to innovate also affect the fi rm’s global engagement. Since we do not observe fi rms for more than one period and valid instruments for our variables of interest are difficult to obtain, we address these selection and omitted variables’ problems making use of the rich set of information available in each cross-section of the survey and show the results in Table 4.

The effect of international activities on innovation may simply re fl ect better managerial

> 25The multinational parents’ fear of leakage of proprietary knowledge and of the imminent threat of imitation by domestic-owned fi rms in countries with weaker property rights mentioned by Saggi (2002), seems to in fl uence the nature of the technology transfers to majority-owned subsidiaries but not so much of those to minority-owned subsidiaries.

> 26Mans fi eld and Romeo (1980) fi nd that U.S. multinational parents transfer more advanced technologies to fully-owned subsidiaries than to minority-owned subsidiaries. Ramachandran (1993) fi nds higher technology transfers from multinational parents to fully-owned subsidiaries than to minority-owned subsidiaries in India. Javorcik (2006) fi nds that multinationals with the most advanced technologies tend to enter into Eastern European countries through majority foreign ownership rather than minority foreign ownership.

15
quality in the fi rms that are engaged in those activities. More entrepreneurial managers are more likely to engage in technological innovations more often but are also more likely to export or import. In column (1), we add to our baseline speci fi cation (column (6) of Table 3) a dummy variable that equals one if the manager has a college or a post-graduate degree. This variable, which proxies for managerial ability, has a positive and signi fi cant effect on the fi rm’s propensity to innovate. More importantly, the effects of technology diffusion through trade and FDI on technological innovation are robust to the control for managerial quality.

Alternatively, foreign-owned fi rms or exporters may have easier access to fi nance through their multinational parents or due to export-promoting policies. If fi rms are credit constrained, lower costs or increased access to fi nance can increase their ability to innovate.<sup>27</sup> Hence, the estimated effects of openness on innovation could be largely due to open fi rms’ better access to fi nance. The fi ndings in column (2) show that access to fi nance is indeed positively correlated with the propensity to innovate.<sup>28</sup> The effects of minority foreign ownership, exports, and imports on innovation are maintained, suggesting that it is not just a better access to fi nance that underlies those effects, but likely it is the access by more open fi rms to a richer knowledge base.

Some industries and regions with a large presence of fi rms integrated into global markets may provide a particularly dynamic environment for innovation to fl ourish. Thus, it is possible that both the engagement of the fi rm but also the engagement of other fi rms in the same industry and region in international activities matter. In column (3), we control for this external effect by including in the regression the share of fi rms in the industry-region that export and the share of fi rms in the industry-region that import. It is reassuring to see that the effects of minority foreign ownership, exports, and imports on innovation are robust to this control. The effects of these “spillover” variables are positive and signi fi cant for importers, but negative for exporters, suggesting some possible market-stealing effects.

> 27King and Levine (1993) argue that the development of fi nancial intermediaries reduces the costs of identifying entrepreneurs more capable of generating innovations. Increased access to fi nance for fi rms can affect innovation through an improved screening of the quality and probability of success of the projects that are fi nanced as well as through their effects on innovation inputs.

> 28Qualitatively similar fi ndings are obtained by Ayyagari et al. (2006) using a smaller sample of countries from the Investment Climate Surveys.

16
More generally, in column (4) we address the problem of potential unobservable policy or geographical factors that could affect the degree of fi rm openness and the propensity to innovate, by controlling for industry-region fi xed effects. Again our main fi ndings are robust. To the extent that the degree of competition is constant across industries and regions, this speci fi cation controls for the degree of competition faced by fi rms. However, it is possible that different fi rms face different competitive pressures. In particular, it is likely that fi rms operating in more competitive markets face stronger pressures to innovate and may also be more engaged in international activities. To address this possibility, we include an explicit measure of competition in the regression shown in column (5). Based on the total number of competitors, we construct dummy variables indicating whether the fi rm faces no competition, weak, medium, or strong competition in the domestic market. Even though we fi nd a positive effect of competition on technological innovation (stronger when the number of competitors is between 4 and 21 fi rms), the fi ndings for the main variables of interest remain robust.<sup>29</sup> A fi rm’s geographical location in the country’s capital city may enhance its innovation prospects due to the proximity to other fi rms, suppliers, clients, and other institutions, while also facilitating its access to global markets through exports and imports and increasing its attractiveness for FDI. The association between openness and innovation could therefore be spuriously due to location. However, the effects of minority foreign ownership, exports, and imports on innovation are qualitatively unchanged in column (6) when our main speci fi cation is estimated using the sample of fi rms located outside their country’s capital city. Similar results are found when considering only those fi rms located outside each country’s capital and second major cities.

The fi ndings in Table 3 show that industries with a higher degree of technological sophistication (high-tech) face and take advantage of more innovation opportunities than traditional industries with a lower degree of technological sophistication (low-tech). So far, we have controlled for such differences using industry fi xed effects. More generally, there may be differences in the role of technology diffusion through trade and FDI for fi rm-level innova-

> 29A non-monotonic relation between innovation and competition is also found for the UK. Aghion et al. (2004) show that the effect of concentration on innovation has an inverted "U"-shape.

17
tion depending on the degree of technological sophistication of the industry. In columns (7) and (8), we report the results from estimating our main speci fi cation separately for fi rms in high-tech industries and low-tech industries, respectively. In both high-tech and low-tech industries, importers have a signi fi cantly higher propensity to innovate and the coefficients are similar to those in column (6) of Table 3. Exporters also have a higher propensity to innovate in both high-tech and low-tech industries, but the effect is stronger in high-tech industries. In high-tech industries, foreign-owned fi rms are not more innovative than domestic-owned fi rms. Finally, in low-tech industries, there is strong evidence that majority foreign-owned fi rms are less likely to innovate than domestic-owned fi rms, while minority foreign-owned fi rms are more likely to innovate than domestic-owned fi rms, as in Table 3. For our developing countries, these fi ndings suggest that in low-tech industries multinational parents invest in majority-owned subsidiaries to take advantage of the availability of cheap labor, using them simply as export platforms. For this purpose, they set-up and use their more advanced technology to produce but do not devote more efforts to technological innovation than domestic-owned fi rms. In contrast, the technology transfers to the local partner by multinational parents that invest in minority-owned subsidiaries generate signi fi cantly more innovation.

While the effect of exports on technological innovations is robust to the control for fi rm and industry-region characteristics, it may still be biased due to reverse causality. Exports may be facilitated by a fi rm’s past technological choices which in turn may also in fl uence its current technological innovation. We try to address this problem in column (9) by comparing non-exporters with those fi rms that have entered export markets more than 10 years prior to the survey. For such exporters, the causal effect is more likely to run from exports and the resulting knowledge diffusion to innovation, rather than the reverse. The point estimate in column (9) is very close to that shown in column (6) of Table 3, suggesting that the reverse causality problem may not be too severe. Similar results (available upon request) are obtained when considering only the fi rms that have entered export markets more than 20 years prior to the survey.

As a robustness check to our main fi ndings, we consider a broader measure of innovation 18
which is a dummy variable equal to one if the fi rm reports having substantially changed its production process (technological innovation) or if the fi rm reports having introduced a new product line or upgraded an existing product line (product innovation). The results from regressions using this broader measure of innovation are shown in Table A.4. Across all speci fi cations, there is evidence of a strong positive correlation between trade and the propensity to innovate. We also fi nd a strong positive effect of minority foreign ownership on the propensity to innovate, which contrasts with the negative effect of majority foreign ownership.

Finally, we investigate to what extent differences in the sources of technology adoption across fi rms can explain why fi rms that are more integrated into global markets tend to innovate more. The baseline regression is our preferred speci fi cation in column (6) of Table 3. In column (1) of Table 5 we control for the fi rm’s R&D efforts. The R&D activities within the fi rm may directly improve the likelihood of technological innovation, or may improve the fi rm’s capacity to absorb external knowledge or technology (Cohen and Levinthal, 1989). Even after controlling for differences in R&D activities across fi rms, we fi nd that the effects of trade and FDI on innovation are robust and similar to those reported in column (6) of Table 3. Moreover, the effect of R&D on technological innovations is positive and signi fi cant: fi rms that engage in R&D activities are 8.8 percentage points more likely to innovate. In column (2), we add to the previous speci fi cation a dummy variable for whether the fi rm has any technological license. The prior here is that fi rms that directly engage in the trade of knowledge or technology through licenses would be more likely to report technological innovations, all else constant. Although our data does not differentiate whether these licensing agreements are of domestic or foreign origin, for a smaller set of countries we have information on the use of technology licensed from a foreign-owned fi rm. The results for this smaller sample are reported in column (3). In both cases, the sign and the magnitudes of the trade and FDI variables remain robust. These results suggest that the use of foreign licenses matters for technological innovations but does not differ much for fi rms that engage in global activities relative to fi rms that do not.<sup>30</sup>

> 30This was also shown in column (4) of Table A3, where fi rms with foreign participation, exporters, or

19
In sum, the fi ndings in this section show that there is a very robust positive association between trade (either exports or imports) and technological innovations. Minority foreign participations are also a better channel for technology diffusion than majority foreign participations. Furthermore, majority foreign-owned fi rms are signi fi cantly less likely to innovate technologically than domestic-owned fi rms, especially in low-tech industries. Although we do not analyze technological spillovers to domestic fi rms, this fi nding is consistent with minority foreign participations bringing greater bene fi ts to the domestic economy than majority foreign participations. These patterns do not seem to be driven by innovation inputs such as R&D activities or the use of licensed technology that directly affect technological innovation.

# 4. Conclusion

This paper uses a fi rm-level dataset for a large number of developing countries to provide new evidence on the importance of technology diffusion through trade and FDI for technological innovations. Unlike most previous studies, we are able to identify whether fi rms have recently adopted new technology, which is arguably a better measure of a technological innovation for the fi rm than its R&D activities or its use of patents. Our fi ndings show a very strong positive correlation between trade and technological innovations at the fi rm level. Importers and exporters are 4.3 and 7.3 percentage points more likely to adopt new technology than fi rms that do not engage in each of these activities, respectively. While these effects may be biased due to the selection of the more competitive fi rms (and hence more prone to adopt new technologies) into these activities, our evidence suggests that this problem is not too severe. We also fi nd strong evidence that, all else constant, majority foreign-owned fi rms are signi fi cantly less likely to engage in technological innovations than domestic-owned fi rms with similar managerial education and access to fi nance operating in the same region and industry. This result is particularly strong in low-tech industries. We interpret this fi nding as evidence that the technology transferred from multinational parents to majority-owned subsidiaries is more mature than that transferred to minority-owned subsidiaries. This fi nding supports the idea that equity joint ventures transfer a more dynamic technology to local fi rms, which importers do not differ systematically in the use of licenses from abroad.

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contrasts with previous empirical evidence and provides a rationale for the policies followed around the world to attract FDI.

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