Comparing the Impact of Investment Climate, Innovation Systems, and International Integration on Firm Productivity in Developing Countries (Multilevel Analysis)

Abstract

This dissertation examines the relative importance of three factors so called investment climate (IC), international integration (II) and innovation systems (IS) on firms of developing countries. Meanwhile, these factors are functioning at different levels

the firm-, industry- and country-level. The current work studies the relative importance of levels as well. In addition, this study identifies certain conditions under which ineffective elements of factors can be effective on labor productivity. The World Bank considered the investment climate as the most important factor for firms productivity in developing countries. However, this study argues that IC has the lowest degree of importance. Because IC factors do not exert influence on firm performance per se

other conditions are necessary for IC in order to be influential. And prior to IC, international integration and innovation system are essential for firm performance. Latecomers in developing countries are highly dependent on already developed knowledge and practices by other countries, and they have access to that through FDI and exports. Therefore II should have the highest degree of importance compared with other factors. In addition, knowledge needs to diffuse within society, which can happen through innovation systems. Thus IS should be the second most important level. Scholars tailored the concept of factors based on the experience of developed countries, thus they followed the system approach, which means they emphasize the country-level as the most important functioning level. But in developing countries, firms, as a main actor in the system, do not have enough capability to work properly within system. Therefore firm-level should be higher in importance in developing countries. Firms with different resource qualities impacted by their environment differently. Firms who are more engaged globally are more exposed to investment climate conditions. And firms with high absorptive capability can enjoy more from a high R&D intense society. To examine our hypothesizes we use the investment climate survey (PICS) database by World Bank conducted in 21 developing countries and 20 industries covering a total number of about 6,219 manufacturing firms. The concept of framework conditions and the nature of data are hierarchal, in such a way that firms are nested in industries and industries are nested in countries. This type of data structure makes several statistical analyses difficult due to issues such as the violation of independent assumptions. Therefore to overcome these problems and to study II, IS and IC concepts in truly a multilevel context this paper conducted multilevel/mixed-effect econometrics technique to analyse data at different levels. First we estimate an intercept only model and we let the random part vary across countries and industries. The intercept only model helps us to estimate the intraclass correlation, which indicates the proportion of variance explained by the grouping structures in the population. Then we add firm-level IS and II variables to the model, consider as the base model. Next we add country-level and industry-level IS, IC and II variables to the base model. Finally we examine interaction effects between variables at the firm- and industry-levels. The findings are as follows: physical and soft infrastructure as proxy variables for IC did not show any significant direct effect on firm productivity, but both elements of international integration namely export and FDI came up as effective on both firm- and industry-levels. However, although both elements of IS, namely R&D and human capital, showed significant effects on the firm-level, only human capital kept its behavior on the country- and industry-levels. The above-mentioned results support our hypothesis that international integration has the highest level of importance to firm productivity in developing countries. And that is followed by innovation systems, as the second most important and investment climate is the least important factor. In addition, firm-level has highest number of significant variables. This result supports our second hypothesis that the firm-level is the most important level. The results also show that after the firm-level, the industry-level has highest number of significant variables which supports the importance of industrial structure for growth policies (Lin, 2009). To ensure the reliability of our argument and results we conduct the same analysis for 3,489 firms in 6 OECD countries within 21 industries. Results showed that innovation systems have the highest level of importance. This is followed by international integration at second level and investment climate is the least important. Also, analysis revealed that country-level is the most important factor in developed countries, followed by the firm- and industry-levels respectively. Results from the interaction analysis are as follows: significant interaction coefficients indicate that a poor investment climate diminishes a firms performance of those who have invested in R&D, export goods, and receive FDI. In addition results revealed that in order for a high R&D-intense and high internationally engaged society to be effective for firm performance, firms need to come forward with an adequate corporate innovation system. Policy implications of the findings are remarkable for development economics. Based on these findings, governments should promote investment and trading environments at beginning stages of development. This should be followed by facilitating conditions for firms to improve their absorptive capability and increase their capacity to engage more in R&D activities. When firms reach a higher level of performance, such as firms in developed countries, effective national innovation systems and R&D policies are useful for a firms productivity growth.