Untangling the link between productivity, exporting and innovation of a firm through Brexit

By Ema Talam  and on twitter @ematalam

It is often claimed that the United Kingdom has benefited from joining European Union in terms of its economic performance. On the other hand, some authors argue that the rate of economic growth in the United Kingdom did not rise as a result of its accession to the European Union in 1973[1] (Coutts et al., 2018).

However, different estimates show that the United Kingdom will experience negative consequences of its exit from European Union, but the magnitudes of those estimates vary. The impacts on productivity are argued and there is no general consensus of the scale that Brexit will affect overall productivity in the United Kingdom.

Coutts et al. (2018, p. 20) state that “no aggregate link exists between trade and productivity for advanced open economies, unlike emerging economies where a relaxation of constraints on trade allow multi-national companies to enter, and to raise both exports and productivity”. At the same time, Dhingra et al. (2017) recognise that losses in terms of productivity are possible and list several factors that may contribute to productivity and welfare losses such as: “reductions in the variety of goods and services, weaker competition, the erosion of vertical production chains, falls in foreign direct investment (FDI), slower technology diffusion, less learning from exports or lower Research and Development” (p. 3).

Productivity, exporting and innovation of a firm are three seemingly distinct concepts. More in depth analysis shows that these concepts are indeed related and that it is almost impossible to examine either one of them without examining the other two. Characteristics of exporters and innovators depict well the extent of the link between the three concepts:

  • Exporters tend to be more productive than non-exporters (Wagner, 2007; Damijan et al., 2010; Caldera, 2010; Movahedi et al., 2017) and often have higher productivity growth (Wagner, 2007).
  • Furthermore, exporters are more likely to innovate (Damijan et al., 2010; Caldera, 2010), spend more on innovation (Caldera, 2010; Monreal-Perez et al., 2012) and have more (major) innovations (Bleaney and Wakelin, 2002; Monreal-Perez et al., 2012) than non-exporters.
  • Innovators tend to be more productive (Bleaney and Wakelin, 2002; Damijan et al., 2010; Caldera, 2010; Cassiman et al., 2010; Movahedi et al., 2017) and are more likely to export (Bleaney and Wakelin, 2002; Damijan et al., 2010; Cassiman et al., 2010) than non-innovators.
  • Exporters and innovators also share the set of common characteristics: they pay higher wages (Bleaney and Wakelin, 2002; Caldera, 2010) and are present in the sectors characterised with higher R&D intensity and greater amount of intra-industry trade (Bleaney and Wakelin, 2002).

A recent report published by Centre for Cities (2018) shows that in Britain, exporters constitute more productive firms. Figure 1 shows that British economy is characterised by large number of firms with low levels of productivity, but also that local service firms are predominantly less productive firms. Exporting firms account 13.2% of all the firms examined. The share of exporting firms among the top ten per cent of the most productive firms in 2015 was 31.2%, while the share of exporting firms among bottom 33 per cent was 5.6% in the same year. (Centre for Cities, 2018).

Figure 1: Productivity of all firms

Figure 1: Productivity of all firms, UK (2015)

Figure 2 Productivity of exporting firms compared to local service firms in the UK (2015)

Source: Centre for Cities (2018) The wrong tail-Why Britain’s ‘long tail’ is not the cause of its productivity problems.

*The report indicates that productivity was calculated as “gross value added per worker at a branch level” (Centre for Cities, 2018).

** Original data source is limited to non-financial business economy

***Only private sector productivity was examined

**** Article in Financial Times (Strauss, 2018) on the report indicates that, in this case, all firms engaged in markets beyond their local one are considered to be exporters. However, it can be assumed that certain portion of these firms export abroad as well.

The link between exporting and productivity is also theoretically grounded. It is commonly hypothesised that exporting and productivity are linked in the following manners:

(1) self-selection hypothesis, suggesting that more productive firms self-select into export markets, and

(2) learning-by-exporting hypothesis, suggesting that firms increase their productivity by participating in export markets (Wagner, 2007). Empirical findings prove the existence of both the link leading from productivity to exporting (Caldera, 2010; Cassiman and Golovko, 2011; Movahedi et al., 2017), as well as the link leading from exporting to productivity (Damijan et al., 2010).

Furthermore, previous research shows that exporting is linked to innovation (Damijan et al., 2010) and, at the same time, that product, process and organisational innovation have an influence on exporting (Basile, 2001; Bleaney and Wakelin, 2002; Caldera, 2010; Cassiman et al., 2010; Cassiman and Golovko, 2011; Monreal-Perez et al., 2012; Fryges et al., 2015; Azar and Ciabuschi, 2017).

Some authors suggest that there exists complementarity between exporting and investment in productivity, in the sense that one raises the profitability of the other (Lileeva and Trefler, 2010). Firm’s productivity can be tackled through factors internal to a firm (i.e. managerial practice and talent, quality of labour and capital inputs, decisions about firm’s structure, etc.) and influenced by the factors that are external to a firm (i.e. productivity spillovers, intramarket competition, regulations, etc.) (Syverson, 2011).

Empirical research has shown that innovation positively influences productivity (Cassiman and Golovko, 2011; Movahedi, Shahbazi and Gaussens, 2017).

Four types of innovation can be distinguished:

(1) product innovation, “the introduction of a good or service that is new or significantly improved with respect to its characteristics or intended uses” (OECD/Eurostat, 2005, p. 48),

(2) process innovation, “the implementation of a new or significantly improved production or delivery method” (OECD/Eurostat, 2005, p. 49),

(3) marketing innovation, “the implementation of a new marketing method involving significant changes in product design or packaging, product placement, product promotion or pricing” (OECD/Eurostat, 2005, p. 49), and

(4) organisational innovation, “the implementation of a new organisational method in the firm’s business practices, workplace organisation or external relations” (OECD/Eurostat, 2005, p. 51). Schmookler (1954) suggests that size of the market is one of the determinants of the level of inventive activities.

Brexit will almost certainly result in larger trade costs for the firms involved. Van Reenen (2016) indicates that there are three distinct categories of trade costs that will increase following Brexit:

“(i) higher tariffs on imports;

(ii) higher nontariff barriers to trade, arising from different regulations, border controls, and the like; and

(iii) the lower likelihood of the United Kingdom participating in future EU integration efforts, such as the continued reduction of nontariff barriers”.

Following the lines of the discussion above, trade costs are likely to have a greater impact on the more productive firms in the British economy. Also, due to the existence and the complexity of the links between exporting, productivity and innovation, adverse effects can be expected to go beyond influences on productivity.

References – blog post – v246

By Ema Talam  and on twitter @ematalam

[1] EEC at the time.

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