Empirical Evidence From Swedish Manufacturing Firms Relationship between R&D and Productivity doc

Masters of Economics of Innovation and Growth. Thesis Empirical Evidence From Swedish Manufacturing Firms Relationship between R&D and Productivity. Prepared by: Mohammed Najim Uddin Supervisor: Hans Lööf Associate Professor, Economics of Innovation and Growth, CESIS. Royal Institute of Technology (KTH). 1 Acknowledgement This dissertation is the partial fulfilment of Master programme in Economics of Innovation and Growth at The Royal Institute of Technology (KTH), in Stockholm Sweden. The paper was the result of a series of meeting with my supervisor Professor Hans Lööf. I am grateful to him for kind direction. I am also grateful to Professor Borje Johansson, Almas Heshmati, Martin Anderson and other professor in the department of Economics of Innovation and Growth during my programme I got help from them. I would like to thank you from my heart for the support, guidance, invaluable suggestions throughout this study. My special thank to Professor Hans Lööf for giving me an opportunity to work on the firm level data set and his valuable instruction. Mr Lööf strongly impressed me during this programme. I highly appreciate to Sofia Norlander and Joanna Wasilewska for their great help in my whole study period in KTH, Sweden. Lots of thanks to my classmates in this program. 2 Content Page 1. Introduction …………………………………………………… 5-7 2. Literature review … 7-15 2.1. The history of economic growth theory ………………… 7-11 2.2. Empirical evidence of R&D and productivity relationship … 11-15 3. Objectives and hypothesis ………………………………………… 15-16 4. Data and methodology analysis ……………………………………. 16-24 4.1. Data and variable analysis ……………………………… 16-19 4.2. Research methodology analysis ….……….……………… 19-24 5. Empirical result analysis ………………………………………… 24-26 6. Limitation ……………………………………………………… 26-27 7. Conclusion ………………………………………………………… 27-28 8. References ………………………………………………………. 29-33 9. Appendix ………………………………………………………… 34-40 3 Abstract Many empirical studies have been introduced to show the relationship among R&D and productivity at the firm level. The motivation of this paper is to extend the literature of the relationship between R&D and productivity level at the firm level. This research paper deals only firms direct benefits that actually gains from conducting the research. The paper is based on 6665 Swedish manufacturing firms’ unbalanced panel data set during the period 1992-2000. To estimate the R&D impact on productivity level this study uses the autoregressive model or dynamic model. This model works on where large number of firms and small number of period’s data are observed. The study employs the econometrics tools OLS, fixed effect and generalized method of moment (GMM) estimators. The research is conducted with and without industry dummy in the model. The empirical results confirm that the R&D expenditure has significant impact on the firm level productivity at the 5% level of significance. The empirical result suggests that industry specific effect has no impact on significant level. _________________________________________________________________ Key words: OLS, fixed effect, generalized methods of moment (GMM) 4 1. Introduction: Research and development (R&D) spending have been increasing all over in the world. It increases the stock of useful knowledge through research and development activity. It is one of the crucial determinants of productivity and economic growth. The neo-classical growth model argues that the long run growth is exogeneously determined by either saving rate or rate of technological change. Neoclassical economics state that technological progression and other external factors are the main sources of economic growth. On the other hand, endogenous growth theory agrues that economic growth is generated from within a system as a direct result of internal processes. Endogenous growth theory explains that growth is usually determined by the production of new technologies and human capital given to the production. More specifically, the theory refers the enhancement of a nation's human capital that will lead to economic growth through new forms of technology, process of specialization, efficient and effective means of production. According to the endogenous growth theory the most important factor for determining the economic growth rate is the rate of advance of a country's use of knowledge stock and its important determinant is R&D productivity. Because R&D expenditure is the source of valuable knowledge that leads to improve innovation, specialization and productivity. Innovation increases product market competition and stimulates the process of creative destruction which brings new business opportunities of the firms. Innovation induces firms to enter and exit from the market. R&D provides benefits two ways: one is direct productivity benefits and another is indirect benefits. The direct productivity benefit occurs through conducting research such as automobile or aircraft manufacturers industry and the indirect benefits come through new technology spreading to others parts of the economy. In the present monopolistic competition market, firms achieve monopolistic power through product differentiation. R&D has a crucial role to obtain product variety. R&D investment result is invention, new ideas, design and productivity increment which can be a source of competitive advantages in the global market economy. The firms can sustain growth through investment in R&D. Productivity is one of the key driving forces of economic growth. The term productivity refers to measures the output from production process per unit of input. 5 To measure the gains from R&D spending the researchers rely on firm level productivity measurement analysis. The available empirical studies have generally confirmed the significant role of R&D investment on productivity level at the firm level. Most of the studies can be divided into two categories. Production function based studies and cost function based studies. The production function based studies show the impact of R&D on productivity level that is R&D elasticity and the cost function based studies show the R&D impact on production cost. Some studies have estimated the rate of return in R&D (CBO -2005). From the literature of productivity measurement studies it can be observed that there is no single measurement of productivity. Broadly, productivity measurement can be classified into two categories: - single factor and multi-factor productivity (MFP) measure. The single factor productivity measure is also called partial productivity measure. Multi-factor productivity again can be two forms one is value added based capital-labour MFP measure and another one is gross output based capital, labour, energy and material (KLEMS) MFP productivity measures. In case of value added concept where value added is considered as firms out put (OECD Manual-2001). The most frequently used productivity measurement methods can be expressed by the following tree diagram: Figure-1: productivity measurement methods: Productivity Measurement production function based Cost function based Single factor productivity Multifactor productivity measurement measurement Value added or sales based capital-labour MFP measurement Gross output based capital, labour, energy and material ( KLEM ) MFP Source: Measurement of aggregate and industry level productivity growth: OECD manual (2001). 6 Among those measurements, most of the studies uses value added based productivity measure. To explore the relationship between R&D and productivity level this research paper uses the value added concept. The research paper will be organized by using seven sections where section two provides literature review, section three present the objectives and hypothesis of this paper, section four explains the data and methodology analysis of the study, section five contains empirical result, Section six focuses on limitation of this study. Finally, in the last section gives some conclusions. 2. Literature review: 2.1. The evolution of growth theory: The growth theory and growth empirics are attractive subjects in economics. The modern concept of economic growth started with the critique of Mercantilism, especially by the physiocrats. During the 16 th to 18 th century the mercantilist believed that nation wealth and power were best served by increasing export and collecting precious metals in return. The mercantilism focused on ruler’s wealth, accumulation of gold or the balance of trade. Physiocracy is a school of thought founded by François Quesnay (1694-1774). This theory originated in France and was most popular during the second half of the 18 th century. Physiocracy is the first well developed theory in economics. This doctrine was dominated by Marquis de Mirabeau, Mercier de la Riviere, Dupont de Nemours, La Tronse, the Abbe Baudeau and others. The main theme of this doctrine was Francois Quesnay’s (1759) axiom that only agriculture yielded a surplus- what he called a net product. The physiocrats believed that the wealth of nations was derived solely from the value of land agriculture or land development. From the viewpoint of modern economics the main weakness is that they only consider agricultural labor to be valuable. Physiocrats viewed the production of goods and services as consumption of the agricultural surplus, while modern economists consider these to be productive activities which add to national income.The most important contribution of the physiocrats was emphasis on productive work as the source of national wealth. The productive capacity itself allows growth and increment of national wealth. The classical economics is the first modern school of economics of thought. Adam Smith “The Wealth of Nations” in 1776 is considered the beginning of this school. Adam Smith, David Ricardo, Thomas Malthus and John Stuart Mill are founders of this school. 7 The "Classical" school is sometimes called the "Surplus" school. Often classical economics school expanded up to William Pretty, Johann Heinrich Von Thunen and Karl Marx. Classical economists explained the growth and development. Adam Smith explained a supply side driven model of growth. This model can be expressed by simple production function: Y = f (L,K,T) Where Y is the output, L is labour, K is capital and T is land. The out put growth (g Y ) was driven by population growth (g L ), investment (g K ) and land growth (g T ) and increases overall productivity (g f ). Smith suggested that growth was related to capital accumulation, technological progress and institutional and social factors. g Y = φ(g f, g L, g K, g T ) Where time was endogenous it depends on the sustenance available to accommodate the increasing workforce. Investment (g K ) was also endogenous: determined by the rate of savings; land growth (g T ) was dependent on the conquest of new lands or technological improvements of fertility of old lands. Technological progress could also increase growth overall. Smith also emphasized improvements in machinery and international trade as engines of growth as they facilitate further specialization. He stated that the division of labour improves growth, was a fundamental argument. David Ricardo (1817) modified Smith idea including diminishing return to land. His most important assumption was that economic growth must decline and end due to the scarcity of land and its diminishing marginal productivity. He showed that how distributional changes between wages, rent, interest and profit affected the prospects for long run capital accumulation and growth. According to Ricardo’s idea output growth requires growth of factor input. But land supply is limited. Land can not be produced or created. As a result two effects occur on growth. Firstly, landowner rents increases overtime reducing the profit of capitalist and secondly, wage goods will be rising in price and this reduces profit as workers require higher wages. As the economy continued to grow, then, by his theory of distribution, profits would be eventually squeezed out by rents and wages. In the limit, Ricardo argued, a "stationary state" would be reached where capitalists will be making near-zero profits and no further accumulation would occur. 8 Ricardo suggested that this decline can be checked by technological improvements and foreign trade. Ricardo first claimed that technical improvements would help push the marginal product of land cultivation upwards and thus allow for more growth. But in his later third edition of his principles, Ricardo modified his position on machinery. He noted that machinery displaces labour and that ‘set free’ might not be reabsorbed elsewhere and thus merely generate downward pressure on wage and thus lower labour income. In order to reabsorb this extra labour without this effect, then the rate of capital accumulation must be increased. Malthus (1796) in his ‘Essay on the Principle of Population." In essence, Malthus said that any growth in the economy would translate into a growth in population. He claimed in his hypothesis that population growth exceed the growth of mean of subsistence. Actual population growth is kept in line with food supply growth by positive checks. If the population growth was not easily checked and would quickly outstrip growth and increasing misery all around. John Stuart Mill (1806-1873) improved little upon Ricardo, Mill first adopted Ricardo's view that the average wage is determined by a fixed amount of capital divided by the number of workers, he stated that other factors play a role in determining wages, among them workers' expectations as well as various institutional factors. Karl Marx (1818-1883) modified the growth theory through his reproduction scheme. He believed that all production belong to labour because workers produce all value within society. The market system allows capitalists, the owner of machinery and factories, to exploit workers denying them a fare share of what they produce. He predicted _______________________________________________________________________ Note: http://cepa.newschool.edu/het/essays/growth/growthcont.htm 9 that capitalist compete for profit that led capitalist to adopt labour saving machinery. He used the multi sectoral context and provided the steady state growth equilibrium. Marx did not believe that labour supply was endogenous to wage. Marx claimed that wage is not determined by necessity or natural factors but rather by bargaining between capitalist and workers. Marx also saw that the profit and raw material as the determinant of savings and capital accumulation. John Maynard Keynes (1936) distinguishes his theory from classical economics. He developed theory that explains determinants of saving, consumption, investment and production. In that theory, the interaction of aggregate demand and aggregate supply determines the level of output and employment in the economy. According to Keynes investment demand is one of the determinants of aggregate demand and that demand is linked to output via the multiplier. He argued that without market imperfections, aggregate demand might fall short of the aggregate productive capacity of its labour and capital. Keynes theory of demand determined equilibrium first extended Sir Roy F. Harrod (Harrod in 1939, Domar in 1946) into a theory of growth that is the ‘Harrod- Domar’ model of growth. The Harrod –Domar model was initially created to help analysis the business cycle. Harrod-Domar (1946) model is used in development economics to explain an economy’s growth rate in terms of the level of savings and productivity of capital. It suggests that there is no natural reason for an economy to have balanced growth. Its implication was that growth depends on the quantity of labour and capital; more investment leads to capital accumulation, which generates economic growth. The neo-classical model was an extension of Harrod-Domar model (1946) that includes new term, productivity growth. The most important contribution was given Robert Solow (1956). Solow and T.W. Swan developed neo-classical model of economic growth which is also called Solow-Swan model or exogenous growth model. The exogenous model shows how economies will naturally tend to steady state. This model explains the long-run economic growth. Solow extended the Harrod-Domar model by including: (a) labour as a factor of production; (b) Diminishing return occur to labour and capital separately. And constant return to scale for both factor combined; and (c) A time varying technology distinct from capital and labour. Capital output ratio is not fixed as they are in 10 [...]... studies on R&D and firm level productivity are used extended form of the Cobb Douglas production function The econometric evidence of these research papers suggests that R&D induces the firm level productivity and growth The coefficient of the R&D is differing from country to country This research paper examines the relationship between R&D and productivity in case of Swedish manufacturing firms The... positive and significant role is found on R&D expenditure and productivity The R&D elasticity is 0.09 This study also showed that the roles are different by the firms sizes and characteristics of technology The empirical result showed that the effects of R&D on productivity improvement are larger for the large sized and high-tech firms than they are for the smaller sized and low-tech firms The evidence from. .. Matteucci and Alessandro Sterlacchini (2005): ICT, R&D and Productivity Growth: Evidence from Italian Manufacturing Firms Università Politecnica delle Marche , Ancona Pilar Beneito (2001): R&D productivity and spillovers at the firm level: Evidence from Spanish panel data Investigaciones Economicas Vol XXV (2), 2001, 289-313 Patrizio Pagano and Fabiano Schivardi (2000): Firm size distribution and growth... Doraszelski, and Jaumandreu, (2006) uses the dynamic model on 1800 Spanish manufacturing firms in nine industries during the 1990s Empirical findings indicate that the link between R&D and productivity is subject to a high degree of uncertainty, nonlinearity, and heterogeneity across firms R&D expenditures stimulate productivity The growth in expected productivity corresponding to observations with R&D expenditures... the relationship between R&D and productivity on 432 US firm for the period 1973-1979 This study uses patent data to classify the firms in technology- based categories and found significant and positive R&D coefficient (0.098) Hall & Mairesse (1995) examined the R&D elasticity on 197 French manufacturing firms for the period 1980 to 19870 The study found the productivity of R&D spending for French manufacturing. .. and Valdemar Smith (1999); The Impact of R&D on Productivity: Evidence from Danish Manufacturing Firms Danish Institute for Studies in Research and Research Policy Mario I Kafouros (2004): R&D and Productivity growth: evidence from the UK Econ Innov New Techn., 2005, Vol 14(6), September, pp 479–497 Mikael Stenkulal (2006): The European Size Distribution of Firms and Employment; IFN Working Paper No 683,... Mohamed Sassenou (1991); R&D and Productivity: A survey of Econometric studies at the firm level NBER working Paper No W3666 30 Jiann-Chyuan Wang and Kuen-Hung Tsai (2002): Productivity Growth and R&D Expenditure in Taiwan’s Manufacturing Firms Chung-Hua Institution for Economic Research Katharine Wakelin (1997): Productivity Growth and R&D Expenditure in UK Manufacturing firms Research Policy 30 (2001)... Denmark and Japan those are mentioned in the literature review Overall, the results confirm a significant role for R&D expenditure in productivity level The evidence of R&D impact that stimulates R&D grants and firms to devote more R&D effort and achieve better performance in terms of productivity 28 References: Alex Coad (2008); Firm growth and scaling of growth rate variance in multiplant firms Economics... Opportunity and Spillovers of R & D: Evidence from Firms' Patents, Profits, and Market Value National Bureau of Economics Research (NBER) Ben Branch (1974): Research and Development Activity and Profitability: A Distributed Lag Analysis The Journal of Political Economy, Vol 82, No 5, pp 999-1011 Bronwyn H Hall & Jacques Mairesse (1992): Exploring the relationship between R&D and productivity in French manufacturing. .. Spanish manufacturing firms 19901996 532 top European R&D investors over the six-year period 2000-2005 78 firms in UK, (1989–2002), 684 Danish manufacturing firms (19871995) 3830 Japanese manufacturing Firms for the period between 1995 and 1998 200 firms in German and UK In each country, 1987 -1996 14 controlling for firm size and industry effects This study has found that the R&D output elasticity . Economics of Innovation and Growth. Thesis Empirical Evidence From Swedish Manufacturing Firms Relationship between R&D and Productivity. . 2.2. Empirical evidence of R&D and productivity relationship … 11-15 3. Objectives and hypothesis ………………………………………… 15-16 4. Data and methodology