Economic Integration and

Innovation
www.italocolantone.com
italo.colantone@unibocconi.it
 Outline and reading material
• “Trade and Innovation” N. KIRIYAMA, Synthesis Report, OECD Trade
Policy Papers, No. 135, OECD Publishing, 2012.

• “Trade induced technical change? The impact of Chinese

imports on innovation, IT and productivity” N. BLOOM, M. DRACA,
J. VAN REENEN, NBER Working Paper No. 16717, 2011.

• “Internationalization and innovation of firms: evidence and

policy” C. ALTOMONTE, T. AQUILANTE, G. BÉKÉS, G.I.P. OTTAVIANO, Economic
Policy, 76:663‐700, 2013.

• “New imported inputs, new domestic products” I. COLANTONE,

R. CRINÒ, Journal of International Economics, 92:147‐165, 2014.
 The basics: 4 types of innovations (OECD)
1. Product Innovations: introduction of goods/services that are
new or significantly improved;

2. Process Innovations: implementation of new or significantly

improved production or delivery methods;

3. Marketing Innovations: implementation of new marketing

methods involving significant changes in product
design/packaging/placement/promotion/pricing;

4. Organizational Innovations: implementation of new

organizational methods in firms’ business practices.

NOVELTY is essential, and can be assessed with respect to the

single firm, the corresponding market, the world.
 Matching Trade and Innovation: Why?
• Already since Ricardo (1817), it is well understood that cross‐
country differences in technology (productivity) are the
sources of comparative advantage and influence trade
patterns (alongside factor endowments).

• For long time, research has focused on the effects of

technological disparities on trade…

• … More recently, we are trying to understand the mechanisms

through which economic integration can affect productivity
growth and technological progress.

• Internationally integrated markets are the environment in

which firms compete => framework conditions matter for
innovation.
 3 types of trade and innovation linkages

1. International technology diffusion: through trade in

goods/services, foreign direct investment (FDI), cross‐border
technology licensing;

2. Competition effects: increased competition through imports

and FDI pushing firms to innovate;

3. The role of Exports: increasing learning opportunities,

incentives and potential returns from innovation on wider
markets.
 Link 1: international technology diffusion
a. Diffusion through imports:
Intuition: trade in tangible goods can facilitate the exchange of intangible
ideas, making new technologies available, determining increases in
productivity and more domestic innovation (e.g. importing new
intermediates, or new capital goods, like machines embodying new tech).

Empirical evidence: growing literature on impact of trade on productivity

growth within firms:
– Decreasing tariffs on inputs lead to TFP growth: Amiti and Konings (2007)
on Indonesia, Topalova and Khandelwal (2011) on India;
– Firms that import inputs improve TFP: Kasahara and Rodrigue (2008) on
Chile, Halpern et al. (2005) on Hungary.

The challenge is isolating learning effects from self‐selection!

Only two studies on the direct impact on product innovation: Goldberg et al.
(2010), Colantone and Crinò (2014)
 Link 1: international technology diffusion
b. Diffusion through FDI:
Intuition: the presence of foreign firms in a host country may generate
“knowledge spillovers”. These can be horizontal (domestic firms learn from foreign
competitors in same industry) or vertical (domestic firms interacting with foreign
suppliers or buyers).

Empirical evidence: many firm‐level studies on productivity growth within firms:

– does TFP increase faster for domestic firms operating in industries where
foreign multinational enterprises (MNEs) are relatively more present?
– are spillovers horizontal or vertical? Do they depend on the nationality of
the foreign firms? Are they the same across different regions in the same
country?
– Does TFP increase faster in domestic firms that are directly acquired by
foreign MNEs? Or maybe the best are acquired? => empirical challenge!
Some relevant references (among many others): Smarzynska‐Javorcik (2004), Keller
and Yeaple (2009), Altomonte and Colantone (2008), Smarzynska‐Javorcik and
Spatareanu (2011) Altomonte and Pennings (2009); see Fons‐Rosen et al. (2013) for a
recent (critical) assessment.

Very few studies showing direct impact of FDI on product (and process)
innovation: Guadalupe et al. (2010), Ito et al. (2010).
 Link 1: international technology diffusion
c. Diffusion through trade in technology:
Intuition: essentially it is licensing of intellectual property (i.e. patents); a firm
may decide not to invest directly in a foreign country, but rather sell the rights
to exploit the technology to local firms => knowledge diffuses cross‐borders.

Empirical evidence: licensing particularly relevant in chemicals (including

pharma), electronic and electrical equipment (e.g. semiconductors), industrial
machinery and equipment including computers (Onodera, 2008).

Nishimura et al. (2005) found positive impact of patent purchases on TFP

growth within firms in Japan.

Gonçalves et al. (2007) found also a positive impact of acquisition of foreign

technology through licensing on the likelihood of subsequent
product/process innovation in Argentina.
 3 types of trade and innovation linkages

1. International technology diffusion: through trade in

goods/services, foreign direct investment (FDI), cross‐border
technology licensing;

2. Competition effects: increased competition through imports

and FDI pushing firms to innovate;

3. The role of Exports: increasing learning opportunities,

incentives and potential returns from innovation on wider
markets.
 Link 2: competition effects
Economic integration in any form implies an increase in
competitive pressure (as you know well, e.g. from Melitz, 2003)

Is higher competition good or bad for innovation?

On one hand, competition reduces the expected rents that

induce firms to invest in innovation (Schumpeter, 1942);

On the other hand, competitive pressure can work as an

incentive for innovation to “escape the competition” (Arrow,
1962, Bloom et al., 2011).

Two factors combined by Aghion et al. (2005): “inverted‐U”

relation, i.e. highest innovation observed in industries witnessing
an intermediate degree of market competition
 Link 2: competition effects
Source: Aghion et al. (2005), based on UK data.
 Link 2: competition effects

Theoretical bottom line: increased competition induced by

economic integration can lead to higher innovation. In particular:

– Product innovation: in case firm strategy is focused on

product differentiation (both horizontal and vertical, i.e.
quality based);

– Process innovation: in case firms pursue a cost‐leadership

strategy (Porter, 1980)… maybe not the smartest thing to
do these days if you are based in US/EU.
 Link 2: competition effects

Empirical Evidence:

Several studies have found increasing trade openness to

determine TFP growth within firms (e.g. Pavcnik, 2002, on
Chilean firms; Eslava et al., 2009, on Colombia).

Direct evidence of a positive impact on innovation activity, as

measured by patents, is provided by Gorodnichenko et al. (2010)
on transition economies, by Bloom et al. (2011) for the EU, by
Aghion et al. (2009) for the UK (in reaction to increasing FDI
inflows).
 3 types of trade and innovation linkages

1. International technology diffusion: through trade in

goods/services, foreign direct investment (FDI), cross‐border
technology licensing;

2. Competition effects: increased competition through imports

and FDI pushing firms to innovate;

3. The role of Exports: increasing learning opportunities,

incentives and potential returns from innovation on wider
markets.
 Link 3: the role of exports

The most efficient firms self‐select into exporting (Melitz, 2003;

Melitz‐Ottaviano, 2008). This is the basis for between effects and
industry‐wide productivity gains through reallocation.

However, exporting firms may also experience a reinforcing

“learning by exporting” effect, leading to within firms
productivity growth and higher innovation. This may happen for
several reasons:
– better access to foreign knowledge;
– higher quality standard to be met on international markets;
– faster learning about market developments;
– technical assistance from overseas buyers;
– higher capacity utilization => scale economies.
 Link 3: the role of exports

Exporting may also have a positive effect on innovation by

increasing firms’ available financial resources and the
incentives/returns to innovation.

Bustos (2011): Melitz model extended to allow for technology

upgrading. Trade liberalization pushes exporting firms to upgrade
as they have higher revenues available to cover the same fixed
cost of innovation.

That is: there is a complementarity of trade and innovation

activities
 Link 3: the role of exports

Empirical Evidence:

Large literature showing that trade and productivity are positively

related: self‐selection? Learning‐by‐exporting? Different studies have
reported heterogeneous results. Overall, selection seems to be always
at work, and learning in several cases (see Wagner, 2007, for an
extensive review).

Some studies have provided direct evidence on innovation activities

(patents or R&D expenditure): Lileeva and Trefler (2010) on Canada;
Bustos (2011) on Argentina; Aw et al. (2011) on Taiwan.
 3 types of trade and innovation linkages

1. Technology diffusion:
“New imported inputs, new domestic products”,
Colantone and Crinò (2014)

2. Competition effects:
“Trade induced technical change? The impact of Chinese
imports on innovation, IT and productivity”, Bloom et al.
(2011)

3. The role of Exports:

“Internationalization and innovation of firms: evidence
and policy”, Altomonte et al. (2013)
 China and EU Innovation: introduction

• Impact of Chinese import competition on patenting, IT

adoption, R&D and TFP at firm level
• “Trade‐induced technical change” through “trapped factors”
• Focus on both between and within effects
• Empirical challenge: check for endogeneity with instrumental
variables, e.g. using shock of Chinese entry in WTO (2001)
• Check for effect of imports from other low‐income countries
• Sample: half million firms in 12 EU countries
• Time‐span 1996‐2007
China and EU Innovation: the trade shock
 China and EU Innovation: “trapped factors” model
1. EU firms can allocate factors (K e L) to produce old low‐tech goods
or to innovate and produce new goods;
2. Chinese imports reduce the relative profitability of low‐tech
products;
3. firms cannot easily dispose of their “trapped” labor and capital
(adjustment costs and firm‐specific investment of workers);
4. this implies that the opportunity cost of innovating and start
producing new goods falls. Inputs are freed up for innovation;
5. hence, an increase in import competition from China induces more
innovation.

According to this model, (1) imports from industrialized countries

should not produce similar effects as they focus more on high‐tech
products; (2) stronger effect for firms with more trapped factors (i.e.
higher TFP).
Do you buy it?
 China and EU Innovation: data
• Firm‐level data from Amadeus (BVD): balance sheet data, firms
classified in industries (primary and secondary codes for import
competition indexes).

• Patent data from European Patent Office (EPO): matching Amadeus

firms to patents “by name”.

• R&D data from Osiris (BVD): just for 4,000 listed firms.

• IT data from Harte Hanks (HH): surveys of about 160,000 firms.

Essential indicator: computers per worker.

• Import data from UN Comtrade: HS 6‐digit goods trade import

flows aggregated up to 4‐digit SIC industries.

 Crucial indicator: IMPCH=MChina/MWorld

China and EU Innovation: specifications

Within effects

Between effects
and Exit
Overall industry
impact
 China and EU Innovation: first results (within)
A 10 p.p. increase in IMPCH is associated to 3.2% increase in patenting.
Just a lawyer effect? No… Same effect for IT/N and R&D.
Positive effect on TFP as well, estimated à la Olley and Pakes (1996).
 China and EU Innovation: endogeneity

• Issue: an unobserved (to the econometrician) technology

shock could jointly be correlated with more innovation in EU
and higher exports in China, determining an upward bias in
the OLS coefficient.
• How to capture the causal effect? Need to isolate the
variation in Chinese imports that is exogenous (i.e.
independent) with respect to EU innovation activities.
• Need for instrumental variables (IV), that have a strong direct
impact on Chinese imports (i.e. powerful instruments)
without also affecting (or being correlated to) EU innovation
through additional channels (i.e. exclusion restriction).
• First IV strategy: exploiting China’s entry in WTO, with
subsequent abolition of MFA quotas in textiles and clothing
(leading to 270% increase in imports after abolition in 2002‐
2005).
 China and EU Innovation: IV results (within)
Instrument: value weighted proportion of HS6 products in the 4‐digit industry that
were covered by MFA quota restriction on China in 2000.

First stage results intuitive: larger growth in imports in industries where quotas
were more relevant.

OLS results are preserved, and IV coefficients are even higher (reason why?)
 China and EU Innovation: IV results (within)
Instrument: initial conditions, they use the 1999 import share of China in each
industry in EU and US imports interacted with overall growth in Chinese import
share in sample. Intuition: capturing growth in imports due to Chinese
comparative advantage measured in 1999.

Qualitatively same results as before: first stage OK, second stage produces IV
coefficients higher than the OLS ones.
 China and EU Innovation: results (between)
A 10 p.p. increase in IMPCH is associated to 3.5% fall in employment; such impact is
mitigated and possibly reversed in high‐tech firms, as identified by the lagged
number of patents per worker (TECH). “Shielding effect” of technology, robust to
IV, unreported)
 China and EU Innovation: results (between)
A 10 p.p. increase in IMPCH is associated to 1.2% decrease in survival probability;
such impact is mitigated and possibly reversed in high‐tech firms, as identified by
the lagged number of patents per worker (TECH). “Shielding effect” of technology,
robust to IV, unreported).
China and EU Innovation: within‐between

Based on the
estimated
coefficients, Chinese
imports account for
14.7% of total
patenting increase
over the period,
even more in 2004‐
2007.

Within and between

components equally
important for
patenting. Within
more relevant for IT
and productivity.
Why so?
 China and EU Innovation: industry‐level results
Firm‐level results capture the within effects. Industry‐level results account for
within, between and exit, including the role of entry not analyzed so far due to
feasibility reasons (i.e. you don’t observe the ex‐ante tech level of a new entrant).
Results broadly consistent with previous table: within accounting for more than
half of total effect, thus any omitted entry effect must be small.
 China and EU Innovation: additional results
Increasing import pressure from other low‐wage countries (GDP per capita less
than 5% of US between 1972 and 2001) is qualitatively similar to that of China, i.e.
coefficients not statistically different.
Import pressure from high‐wage countries does not have impact, consistent with
the “trapped factors” theory. Same results for IT and TFP.
 China and EU Innovation: additional results
In line with the “trapped factor” model, initial TFP is negatively correlated with
subsequent patent growth (as the opportunity cost of innovating is higher for
firms with more trapped factors). However, when the Chinese trade shock hits,
more productive firms are more likely to respond by innovating.
 China and EU Innovation: additional results
Chinese imports increase the wage bill share of college educated workers.
IT‐intensity does the same. When both variables are included they have lower
coefficients, suggesting that import pressure and IT are indeed related.
 China and EU Innovation: additional results
Offshoring to China does not have a significant impact on patenting;

However, it does have an impact on IT and TFP.

Intuition: offshoring involves low‐IT intensive activities.

 China and EU Innovation: additional results
On average, 11% of plants switch industry at the 4‐digit level in five years. Switching is
more likely the higher the increase in Chinese import pressure.
Switching itself is related to higher IT intensity, but marginally as compared to Chinese
pressure, i.e. most of Chinese impact does not take place through industry switching. Yet,
product switching may take place…
 China and EU Innovation: summary of findings

1. Within effect: firms facing higher levels of Chinese import

competition create more patents, spend more on R&D, raise
their IT intensity and TFP.
2. Between effect: firms with lower levels of patenting, IT
and/or TFP shrink and exit much more rapidly than high‐tech
firms in response to Chinese competition.
The combined impact of the two channels (both relevant) is to
cause faster technological upgrading in industries most
affected by Chinese imports.
China accounts for about 15% of tech upgrading for 2000‐
2007, even 20% in 2004‐2007.
Similar impact for other low‐income countries, not for rich
ones.
 3 types of trade and innovation linkages

1. Technology diffusion:
“New imported inputs, new domestic products”,
Colantone and Crinò (2014)

2. Competition effects:
“Trade induced technical change? The impact of Chinese
imports on innovation, IT and productivity”, Bloom et al.
(2011)

3. The role of Exports:

“Internationalization and innovation of firms: evidence
and policy”, Altomonte et al. (2013)
 Internationalization and innovation: introduction
• Studying patterns of interaction among firm‐level
internationalization, innovation and productivity dynamics.

• Rich representative database covering 7 EU countries: Austria,

France, Germany, Hungary, Italy, Spain, UK.

• Analysis of several indicators of internationalization and innovation.

• Extensive descriptive analysis.

• OLS regressions and IV analysis of causality from innovation to

internationalization.

• Discussion of policy implications.

 Internationalization and innovation: data
• EFIGE survey data, developed by researchers across countries with EU
funding, publicly available @
http://www.bruegel.org/datasets/efigedataset/
• “Stratified sample”, representative of manufacturing sector by industry,
region, firm‐size (exception of firms<10 employees).
• Data comparable across countries (same questionnaire and time period).
Cross‐section for 2008 (covering previous years in same cases though).
• TFP estimated à la Lev‐Pet by matching EFIGE with Amadeus, 2001‐2009.
 Internationalization and innovation: variables
• Internationalization intensity: number of internationalization modes in
which a firm is active simultaneously, from 0 to 5.

1. Exporter: if the firm has sold abroad, directly from its home country,
some or all of its own products/services in 2008 and/or previous years.
2. Importer: if the firm has purchased at least part of its intermediate goods
from abroad in 2008 and previous years.
3. Outsourcee: if the firm produces in response to receiving an order from
another non‐domestic firm.
4. Outsourcer: if the firm’s turnover is derived, at least in part, from
production activities carried out abroad through contracts and
agreements in 2008, or if the firm purchased services from abroad in
2008 or previous years.
5. FDI maker: if the firm derives at least part of its turnover from
production activities abroad based on FDI in 2008, or if the firm acquired
(totally or partially) or incorporated other foreign firms between 2007
and 2009 or has at least one foreign affiliate (i.e. the FDI maker holds at
least 10% of the foreign affiliate’s shares).

Notice: there’s much more than simple exporting!

 Internationalization and innovation: variables
• Innovation intensity: number of innovation modes in which a firm
is active simultaneously, from 0 to 6, but there are 7 modes…

• Number of IT solutions (0–3):

– Internal information management (e.g. SAP/CMS)
– Sales IT, e‐commerce (online purchasing/online sales)
– Supply chain management (of sales/purchase network)
• Number of successful innovations (0–2):
– Applied for a patent and/or registered a trade mark
– Registered an industrial design
• Number of R&D sources exploited (0–2):
– R&D activities carried out in‐house
– R&D activities acquired from partners

Notice: no self‐assessed product/process innovation!

 Internationalization and innovation: descriptives
• 77% of firms active abroad in some way.
• Exporting more frequent mode, still 49% import. Only 10% FDI
makers.
• Clear ranking of size and productivity <=> self‐selection, i.e.
FDI requires higher fixed costs than exporting.
 Internationalization and innovation: descriptives

• Only 3% engage in everything, so‐called “happy few”

• Size and productivity grow with internationalization intensity.
• Sunk costs and complementarities among the various modes.
 Internationalization and innovation: descriptives
• 87% of firms active in some innovation mode, higher than
usual 50%... It’s a broad definition.
• IT management and supply chain most common modes.
• Larger firms more involved in less frequent activities. No
trends for productivity.
 Internationalization and innovation: descriptives

• Size and productivity grow with innovation intensity.

Internationalization and innovation: descriptives
 Internationalization and innovation: descriptives
• Most firms appear to engage in few innovation/internationalization
modes (panel a)
• But the bulk of employment is accounted for by firms engaged in
several modes (panel b)
 Internationalization and innovation: specifications

Internationalization and innovation intensity are firm specific

and refer to year 2008, i.e. cross‐sectional analysis

j indexes countries, k industries and n size‐classes

 Internationalization and innovation: first results
• Positive correlation between innovation and internationalization
intensity, robust to controlling for fixed effects and TFP, which in
principle is positively associated to both.
• A unit increase in innovation intensity is associated to 0.3 growth in
internationalization intensity.
 Internationalization and innovation: endogeneity

• Issue: results might suffer from a reverse causality problem,

i.e. higher internationalization determining more innovation.

• How to capture the causal effect? Need to isolate the

variation in innovation activities that is exogenous (i.e.
independent) with respect to internationalization.

• Need for instrumental variables (IV), that have a strong direct

impact on innovation (i.e. powerful instruments) without also
affecting (or being correlated to) internationalization through
additional channels (i.e. exclusion restriction).
 Internationalization and innovation: endogeneity

• 2 instrumental variables employed:

1. Firms R&D incentives: share of firms that benefited from

R&D public incentives in 2007‐2009 in each industry‐country
pair. Exogenous if firms did not influence the set‐up of policy.

2. R&D intensity: share of R&D investment over value added in

each industry‐country pair in 2002‐2006. OECD data more
general than the sample.
 Internationalization and innovation: instruments
• Correlation of instruments with innovation intensity not
high… problem of weak instruments
 Internationalization and innovation: IV results
• First stage intuitive, yet small F. IV results in line with OLS,
although with larger coefficient.
 Internationalization and innovation: milieux
• A milieu is an industry‐country pair, classified as high or low
innovation intensity according to simple average of
corresponding firms, i.e. above or below.

• In more innovative milieux the share of internationalized

firms is higher, especially for exporters.
 Internationalization and innovation: implications

• Results show clearly that internationalization and innovation

are intertwined. This calls for a more coordinated policy
approach.

• At the moment, innovation policy managed at EU level, while

single countries engage in export promotion…

• Export promotion addresses only part of the spectrum of

internationalization activities. Need for more comprehensive
support programs.