Innovation by firms is an important driver of factor productivity and long-term economic growth around the world.1 As Chapter 1 explains, innovation in technologically developed countries typically entails research and development (R&D) and the invention and subsequent patenting of new products and technologies. In less advanced economies, innovation often involves imitation, with firms adopting existing products and processes and adapting them to local circumstances.2 Such innovation tends to be about catching up with the technological frontier, rather than advancing that frontier.
As firms adopt products and processes that have been developed elsewhere, technologies gradually spread across and within countries. The speed of this process varies greatly from country to country, which can explain up to a quarter of total variation in national income levels.3 Despite the central role that such technological diffusion plays in determining growth outcomes, the mechanisms that underpin the spread of new products and processes remain poorly understood. This chapter focuses on one such mechanism: the impact that funding constraints have on firms’ adoption of technology.
Funding constraints may limit the adoption of technology, as external inventions (which are typically context-specific and involve tacit know-how) are costly to integrate into a firm’s production structure. Firms therefore need sufficient financial resources to properly adapt external technologies, products and processes to their local circumstances. If insufficient funding is available, businesses in emerging markets may be unable to fully exploit the easy option of R&D that has been carried out elsewhere. Such firms remain stuck in low-productivity activities, and this may, at country level, contribute to the persistence of divergent growth patterns around the world.
Exactly how – and how much – external finance helps firms to innovate, be it through R&D or the adoption of existing products and processes, remains a matter of debate. One key problem hampering this discussion is the dearth of firm-level information on these two forms of innovation. The EBRD and World Bank’s fifth Business Environment and Enterprise Performance Survey (BEEPS V) goes some way towards remedying this problem.
The empirical analysis contained in this chapter comprises two closely related assessments. First, detailed data about banking structures in towns and cities across the transition region are used to explain the severity of the credit constraints experienced by individual firms in these areas. Second, information on these credit constraints is then used to explain why certain firms innovate more than others.4
The transition region is an interesting place to explore the relationship between access to finance and firm-level innovation, given that – as in other large emerging markets, such as India and China – firms there continue to be plagued by credit constraints.5 At the same time, these firms also perform poorly when it comes to adopting technology. For instance, in the World Economic Forum’s Global Competitiveness Report 2013-2014, Russia is ranked 126th out of 148 countries in terms of firm-level absorption of technology.6