R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

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1 R&D, International Sourcing, and the Joint Impact on Firm Performance Esther Ann Boler, Andreas Moxnes, and Karen Helene Ulltveit-Moe American Economic Review (2015) Presented by Beatriz González April 2016 R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

2 Outline 1 Motivation 2 The Data 3 Empirical Regularities 4 Reduce form estimation: Diff-in-diff analysis. 5 The Theoretical Model 6 Structural Estimation 7 Simulation 8 Conclusions R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

3 Motivation Evidence on the following two facts: 1 Strong positive impact of access to imported intermediates on firm performance. 2 Investment in R&D stimulates the endogenous evolution of productivity. How do R&D and international sourcing interact and affect productivity? Basic Idea: Incentive to invest in R&D responds to firms access to imported inputs and viceversa Cost reduction!! R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

4 Motivation Propose a quantitative model with heterogeneous firms that features R&D and import complementarity. 1 Trade liberalization lower marginal input costs More resources available Increase intensive and extensive margin of R&D 2 Lower R&D costs higher returns to R&D and import of inputs cost savings R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

5 Motivation Propose a quantitative model with heterogeneous firms that features R&D and import complementarity. 1 Trade liberalization lower marginal input costs More resources available Increase intensive and extensive margin of R&D 2 Lower R&D costs higher returns to R&D and import of inputs cost savings Contribution Find evidence in the data and propose a model that features complementarities between R&D investments and import of intermediates, a novel fact in the literature. R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

6 Motivation How do they do it? Outline of the presentation: 1 Find some empirical regularities. R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

7 Motivation How do they do it? Outline of the presentation: 1 Find some empirical regularities. 2 Reduced form evidence: lower R&D costs more R&D and more outsourcing. Diff-in-diff approach with data from a natural experiment in Norway. R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

8 Motivation How do they do it? Outline of the presentation: 1 Find some empirical regularities. 2 Reduced form evidence: lower R&D costs more R&D and more outsourcing. Diff-in-diff approach with data from a natural experiment in Norway. 3 Theoretical model of heterogeneous firms, where R&D and imports are subject to fixed costs. R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

9 Motivation How do they do it? Outline of the presentation: 1 Find some empirical regularities. 2 Reduced form evidence: lower R&D costs more R&D and more outsourcing. Diff-in-diff approach with data from a natural experiment in Norway. 3 Theoretical model of heterogeneous firms, where R&D and imports are subject to fixed costs. 4 Structural estimation of returns to R&D and imports. Disentangle direct effect of R&D on marginal cost and revenue from the indirect effect through its impact on equilibrium imports R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

10 The Data Biennial panel of Norwegian manufacturing firms for the period , gathered from three different sources 1 Statistics Norway s Capital database, with balance sheet information from non-oil manufacturing firms of about 8,000 firms per year. 2 Information of firm-level import from customs declarations. 3 Statistics Norway s R&D survey. Merge all three sources based on a unique firm identifier. R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

11 Empirical Regularities Fact 1: Only a subset of firms invest in R&D. Among the firms that do,almost all firms import. Fact 2: Firms investing in R&D are larger, source more foreign products, have a higher import share and labor productivity compared to non-r&d firms THE AMERICAN ECONOMIC REVIEW DECEMBER 2015 Table 1 R&D Investment and Import Participation, 2003 R&D investment No Yes Importing Total No Yes Total Note: Percent of firms with positive R&D investment and/or imports in Table 2 R&D versus Non-R&D Firms, 2003 R&D firms Non-R&D firms Employees Number of imported products Import share Labor productivity Observations Notes: Imported products refer to unique HS four-digit products. R&D firms are firms with positive R&D investment. Import share is defined as firm import value relative to operating costs. Labor productivity is defined as real value added relative to employees in 1,000 NOK. All numbers are simple averages across the two groups. matched with Statistics Norway s R&D survey. The survey provides biennial information on firm-level R&D investment and R&D personnel for a subset of the firms Presented by Beatriz González in (UC3M) the manufacturing R&D, sector. International 5 Further details Sourcing, on the and R&D the survey Joint are Impact provided on in the Firm Performance April / 25

12 Empirical Regularities Fact 3: Firms starting to invest in R&D grow faster,increase their import share and the number of imported varieties compared to all other firms. Fact 4: The extensive margin accounts for a substantial part of year-to-year changes in R&D investments THE AMERICAN ECONOMIC REVIEW DECEMBER Starting R&D Stopping R&D Continuing R&D Percentage change Figure 1. Decomposition of Changes in R&D Notes: Changes in R&D investments between period t 2 and t. Years at the horizontal axis refer to year t. continuing R&D performers. In all periods, the extensive margin (defined as the R&D starters and stoppers) accounts for the majority of the total change in R&D Presented by Beatriz González investments. (UC3M) R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

13 Exploiting a natural experiment Introduction of a tax credit for R&D expenditures in January Allow to deduct from taxes payable 20% of their R&D expenditures, capped at expenditures exceeding NOK 4 million. Activities under R&D definition regulated by the Research Council of Norway. Change of policy was unexpected THE AMERICAN ECONOMIC REVIEW DECEMBER Share importing firms Share R&D firms 0.6 Share importing firms Share R&D firms Figure 2. Share of R&D and Importing Firms Note: A firm is defined as an R&D firm if R&D spending > 0. Presented by Beatriz González same (UC3M) time, there R&D, was a International surge in the average Sourcing, number and of the imported Joint products, Impact with on Firm an Performance April / 25 12

14 Did a reduction in R&D costs actually lead to an increase in R&D expenditures? H 1i = 1 average pre-reform R&D in 1999 and 2001 was less than NOK 4 million. Differences-in-differences model. y it = α i + δ t + β t (H 1i xδ t ) + γx it + ɛ it (1) Correlated random trend model in first differences. y it = δ t + g i + β (H 1i xt 2002) + γ X it + ɛ it (2) R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

15 Differences in differences model VOL. 105 NO. 12 BØLER ET AL.: TECHNOLOGICAL CHANGE, INTERNATIONAL SOURCING 3717 Table 4 The R&D Policy Reform and R&D Expenditure (1) (2) (3) (4) (5) (6) (7) 1999 H (0.11) (0.11) (0.11) 2001 H (0.12) (0.12) (0.12) 2003 H 0.40*** 0.25* 0.24* (0.14) (0.13) (0.14) 2005 H 0.24* (0.13) (0.13) (0.13) > 2002 H 0.54*** 0.35** 0.29** 0.03 (0.14) (0.14) (0.15) (0.22) Control group H 1 H 2 H 3 H 1 H 2 H 3 H 1 Firm controls Yes Yes Yes Yes Yes Yes Yes Firm fixed effects Yes Yes Yes Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes Yes Yes Yes Threshold 4 mill 4 mill 4 mill 4 mill 4 mill 4 mill 8 mill Observations 1,635 1,635 1, Firms Notes: Dependent variable R&D expenditure in logs. Standard errors in parentheses clustered by firm. Control groups defined based on: H 1 : actual R&D, H 2 : predicted R&D, H 3 : industry R&D (see Section IIB). Firm controls: employment, capital stock, labor productivity (all in logs), a firm exit, and a firm entry indicator. *** Significant at the 1 percent level. ** Significant at the 5 percent level. * Significant at the 10 percent level. Presented by Beatriz and González 8 million (UC3M) (placebo R&D, treatment) International with Sourcing, firms with and ex theante JointR&D Impactspending on Firm Performance of more April / 25

16 Did a reduction in R&D costs also impacted the number of imported goods? Fixed-effects Poisson pseudo-mle Number of imported products n it Poisson(µ it ), where the conditional expectation of µ it is E [n it ] = exp [α i + δ t + η(h 1i xδ t ) + γx it ] (3) Differencing is not possible Allow for group-specific trends. E [n it ] = exp [α i + δ t + g(txh 1i ) + β(h 1i xt 2002) + γx it ] (4) R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

17 3718 THE AMERICAN ECONOMIC REVIEW DECEMBER 2015 Fixed-effects Poisson pseudo-mle Table 5 The R&D Policy Reform and Number of Imported Products (1) (2) (3) (4) (5) (6) (7) 1999 H (0.03) (0.03) (0.03) 2001 H 0.06* 0.11*** 0.04 (0.03) (0.04) (0.04) 2003 H 0.17*** 0.22*** 0.15*** (0.04) (0.05) (0.05) 2005 H 0.17*** 0.22*** 0.16*** (0.04) (0.05) (0.05) > 2002 H 0.08** 0.08* 0.14*** 0.03 (0.04) (0.04) (0.04) (0.06) Control group H 1 H 2 H 3 H 1 H 2 H 3 H 1 Group trends No No No Yes Yes Yes Yes Firm controls Yes Yes Yes Yes Yes Yes Yes Firm fixed effects Yes Yes Yes Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes Yes Yes Yes Threshold 4 mill 4 mill 4 mill 4 mill 4 mill 4 mill 8 mill Observations 3,411 3,411 3,399 3,411 3,411 3, Firms Notes: Poisson MLE model. Standard errors in parentheses clustered by firm. Control groups and group trends defined based on: H 1 : actual R&D, H 2 : predicted R&D, H 3 : industry R&D (see Section IIB). Firm controls: employment, capital stock, labor productivity (all in logs), a firm exit, and a firm entry indicator. *** Significant at the 1 percent level. ** Significant at the 5 percent level. * Significant at the 10 percent level. Robustness checks. In sum, by exploiting the natural experiment of the policy change, we find evidence González of not only (UC3M) more R&D, International spending but Sourcing, also more and the sourcing Joint Impact of foreign on Firminputs Performance April as a / Presented by Beatriz 25

18 The Theoretical Model Endogenous productivity and input prices. R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

19 The Theoretical Model Endogenous productivity and input prices. Monopolistic competition: demand of a standrad Dixit-Stiglitz form, with constant markup over marginal cost. y it = φ it Φ t p η it ( ) η p it = η 1 c it R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

20 The Theoretical Model Endogenous productivity and input prices. Monopolistic competition: demand of a standrad Dixit-Stiglitz form, with constant markup over marginal cost. Production is given by y it = φ it Φ t p η it ( ) η p it = η 1 c it lny it = β l lnl it + β k lnk it + γln V it }{{} Π J j=1 v γ j /( J j=1 γ j ) ijt + ω it (5) R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

21 The Theoretical Model Short-run marginal costs, conditional on capital stock k it lnc it = 1 β l + γ [κ 1 + (1 β l γ)lny it β k + β l lnw t + γlnq it ω it ] (6) R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

22 The Theoretical Model Short-run marginal costs, conditional on capital stock k it lnc it = 1 β l + γ [κ 1 + (1 β l γ)lny it β k + β l lnw t + γlnq it ω it ] Intermediate inputs. Quantities [ ] θ/(θ 1) v ijt = (b j x ijtf ) (θ 1)/θ + x (θ 1)/θ ijth (7) (6) R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

23 The Theoretical Model Short-run marginal costs, conditional on capital stock k it lnc it = 1 β l + γ [κ 1 + (1 β l γ)lny it β k + β l lnw t + γlnq it ω it ] Intermediate inputs. Quantities [ ] θ/(θ 1) v ijt = (b j x ijtf ) (θ 1)/θ + x (θ 1)/θ ijth (7) Prices q ijt = { 1 if j domestic good 1 + ( q jtf /b jt ) 1/(1 θ) < 1 if j domestic+foreign (6) R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

24 The Theoretical Model Short-run marginal costs, conditional on capital stock k it lnc it = 1 β l + γ [κ 1 + (1 β l γ)lny it β k + β l lnw t + γlnq it ω it ] Intermediate inputs. Quantities [ ] θ/(θ 1) v ijt = (b j x ijtf ) (θ 1)/θ + x (θ 1)/θ ijth (7) Prices (6) q ijt = { 1 if j domestic good 1 + ( q jtf /b jt ) 1/(1 θ) < 1 if j domestic+foreign Cost reduction of composite good j when imports are used. a tj = 1 θ 1 ln [ 1 + ( q jtf /b jt ) 1/(1 θ)] (8) R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

25 The Theoretical Model Revenue function lnr it (Φ t, k it, w t, a, n it, ω it ) = κ ς lnφ t + η 1 (β k lnk it β l lnw t aγ G(n it )) + ω ς }{{} it + ɛ it (9) j γ j /γ Choose n it to maximize profits: Π it (ω it, Θ it ) = max {π it(φ t, k it, w t, a, n it, ω it ) n it f i } (10) n it [0,1,...,J] R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

26 The Theoretical Model R&D investments Firm performance evolves as a controlled first-order Markov process ω it = α 0 + α 1 ω it 1 + α 2 ω 2 it 1 + α 3 d it 1 + ξ it (11) d it 1 = 1 if R&D investment in t-1 is greater than 0. Value function of the firm. V (ω it ; Θ it ) = Π it (ω it, Θ it )+ max d it {δe [V (ω it+1 ω it, d it = 1; Θ it )] f d, δe [V (ω it+1 ω it, d it = 0; Θ it )]} (12) R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

27 Main take-aways of the theoretical model Proposition 1 The policy function for R&D is d it = 1 if ω it > ω(θ it, f d ), d it = 0 ow. Lower sourcing costs in year t and all future periods (higher a) lowers the threshold ω() This happens since E [π it+1 (ω it, d it = 1, Θ it )] a > E [π it+1(ω it, d it = 0, Θ it )] a R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

28 Main take-aways of the theoretical model Proposition 1 The policy function for R&D is d it = 1 if ω it > ω(θ it, f d ), d it = 0 ow. Lower sourcing costs in year t and all future periods (higher a) lowers the threshold ω() This happens since Proposition 2 E [π it+1 (ω it, d it = 1, Θ it )] a > E [π it+1(ω it, d it = 0, Θ it )] a Lower R&D cost f d weakly increase the expected optimal number of imported products in year t+1 for firms induced to invest in R&D in year t. Since the optimal number of imported products n it (ω it, Θ it ) is weakly incresing in ω it. Therefore E [ n it+1 ω it, d it = 1, Θ it ) ] > E [ n it+1 ω it, d it = 0, Θ it ) ] R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

29 Structural Estimation Main goal: estimate the model and quantify the returns to R&D and imports, assesing both the direct and indirect effect on marginal costs. R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

30 Structural Estimation Main goal: estimate the model and quantify the returns to R&D and imports, assesing both the direct and indirect effect on marginal costs. First stage. Estimate the revenue function (9) by OLS lnr it = κ 2 + δ t + h(m it, k it, n it ) + ɛ it (13) Industry-wide demand and cost trends δ t = lnφ t ζ (η 1)β l lnw t ζ Firm specific variables [ ] η 1 h(m it, k it, n it ) = [β k lnk it + γag(n it )] + F (m it, k it, n it ) ζ h() approximated by linear combination of lnmit, lnk it, G(n it ) and its squares. R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

31 Structural Estimation Second stage. Use predicted h it to rewrite performance ˆω it = ĥ it β k lnk it γ ag(n it ) (14) Use this to subsitute ωit, ω it 1 into equation (11) ] ĥ it = α 0 +βk lnk it +γ ag(n it )+α 1 [ĥit 1 βk lnk it 1 γ ag(n it 1 ) + α 2 [ĥit 1 β k lnk it 1 γ ag(n it 1 )] 2 + α3 d it 1 + ε it (15) Estimate this equation by GMM Introduce instruments!!!!!! R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

32 3732 THE AMERICAN ECONOMIC REVIEW DECEMBER 2015 GMM Estimates Table 10 GMM Estimates Baseline (1) n exogenous (2) No imports (3) Cont. R&D (4) Capital ( β k ) 0.69*** 0.74*** 0.80*** 0.68*** (0.05) (0.04) (0.03) (0.05) No. imported products ( a γ ) 1.06*** 0.66*** 1.05*** (0.32) (0.17) (0.32) Productivit y t 1 ( α 1 ) 0.42*** 0.43*** 0.45*** 0.41*** (0.05) (0.05) (0.05) (0.05) 2 Productivit y t 1 ( α 2 ) 0.04*** 0.04*** 0.04*** 0.04*** (0.01) (0.01) (0.01) (0.01) R& D t 1 ( α 3 ) 0.08*** 0.08*** 0.10*** 0.01*** (0.03) (0.04) (0.03) (0.00) Smal l i ( α S 3 ) 0.10** 0.09** 0.10** 0.01** (0.04) (0.04) (0.04) (0.00) Industry fixed effects Yes Yes Yes Yes Observations 2,495 2,495 2,495 2,495 Firms Notes: Bootstrapped standard errors in parentheses, clustered by firm. Bootstrap is performed with 250 repetitions; firms are sampled with replacement, keeping their entire time path together. R&D is a binary variable in columns 1 3, and log(1 + R&D expenditure) in column 4. Estimates of constant term omitted from table. *** Significant at the 1 percent level. ** Significant at the 5 percent level. * Significant at the 10 percent level. R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

33 Simulation Quantifying effects and importance. Calculate lnˆr i2001 using estimates from first stage equation (13). Given γ a from the second stage, construct vector of revenues for any potential choice of n. Compute ni, and gross and net profits. R&D starters:set of firms not investing in R&D in 2001 but were investing in 2005 (treatment group). { lnˆr i cf lnˆr cf (n) = lnˆr cf i2001 i2001 (n) (n) + dω for R&D starters for rest of firms Let R&D starters reoptimize ni cf... compare ni cf vs ni. R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

34 Simulation Quantifying effects and importance THE AMERICAN ECONOMIC REVIEW DECEMBER 2015 Table 12 Simulation Value Target moments Share non-importers SD ln ( n i 2001 / r it 2001 ) 1.38 Calibrated parameters 5.32 σ ln f 1.36 Percent counterfactual change in n i Ω n i cf / i Ω n i 7.7 Percent revenue growth for R&D starters, total i Ω r ˆ cf i ( n cf i )/ i Ω r ˆ i 2001 ( n i ) 10.3 Percent revenue growth for R&D starters, no import adjustment i Ω r ˆ cf i ( n i )/ i Ω r ˆ i 2001 ( n i ) 8.3 deviation of ln ( n i /r ˆ i 2001 ( n i )) in the model to the same standard deviation in the data. This results in = 4.75, which equals US$ 34,100 or 0.14 percent of median revenue. All target moments R&D, and International calibrated Sourcing, values and are the Joint summarized Impact on Firm in Table Performance 12. The April / 25

35 Conclusions Document and study the relationship between R&D investment and international sourcing. Propose a model with a simple mechanism for complementarity between investment in R&D and trade in intermediaries. Develop a structural estimator to quantify the returns of both activities. Revenue growth among R&D starters: 1/5 comes from sourcing more foreign products, while the remaining comes from R&D investment. International trade amplifies the positive impact of innovation policies on performance and growth. R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25

36 Thank You! R&D, International Sourcing, and the Joint Impact on Firm Performance April / 25