Factors, which influence innovations: theory and evidence from other studies

The description of the innovation data, provided in the previous section, allows to make several conclusions. In the last three years about 40% of Russian firms introduced absolutely new or imitated products and/or technologies. The percentage of imitations or incremental changes was slightly higher than the percentage of innovations. Most of innovations are financed by retained earnings, and enterprisers consider lack of retained earnings as major obstacle to innovations. Only small number of firms uses banking finance, although those, who use it, finance almost half of their innovation expenditure out of this source. Often, firms do not use banking credits not because it is not available, but because of habit, or because they are reluctant to do so. As a result, the percentage of firms, complaining that external finance is unavailable is smaller than the percentage of firms, complaining about lack of retained earnings. Soviet-times nostalgia explains the fact that a large percentage of firms in both samples complains that government do not participate in financing their innovations. Problems with quality of infrastructure, personnel or general uncertainty are considered as much less important than financial problems, and ranking of these problems can differ from one source of data to another.

Table 4 Barriers to innovation activities.

Numbers correspond to the percentages of those enterprises, which answered to this question. In both sample both firms, which conduct innovations, and which do not do innovations are included. In the IET case numbers do not sum up to 100% in those cases, where some respondents chose “difficult to answer” option.

The problem with such self-evaluation of barriers to innovations by enterprises is that it misses the effect of some factors, which stimulate innovations, but maybe perceived by managers as obstacle to innovations. Among such factors, competition has, probably, attracted most of attention in the literature. Clearly, by reducing profits competition can have negative effect on innovations. The growth literature until recently was dominated by such Shumpeterian ideas (Dasgupta-Stiglitz (1980), Aghion-Howitt (1992), Caballero-Jaffe (1993)). This theory was not supported by empirical findings, which demonstrated positive correlation between product market competition and innovative output (Geroski (1995), Nickel (1996), Blundell, Griffith and Van Reenen (1999)). Positive relation between competition and innovations can be generated in the model, where competition increases incentives to innovate for satisfying managers, who minimize their effort subject to staying in business (Aghion-Dewatripont-Rey, 1999). Recently, various theoretical justifications of an inverse U-shape relationship were proposed (Aghion, Harris and Vickers (1997), Aghion, Harris, Howitt and Vickers (2001), Aghion and Howitt (2002), Aghion, Bloom, Blundell, Griffith, Howitt (2002)). In these models firms innovate in order to increase the post-innovation rent in comparison to the pre-innovation rent in the neck-to neck competition environment. The difference of this model from the traditional Shumpeterian models is that incumbent firms are also allowed to innovate.

Empirical literature from the developed countries supports the hypothesis of an inverted U-shape relationship between product market competition and innovations. Aghion, Bloom, Blundell, Griffith, Howitt (2002)). Blundell, Griffith, and Van Reenen (1995, 1999) find positive association between the number of innovations and patents, and increase in domestic competition and trade openness. Evidence from Central and Eastern European (CEES) transition countries is mixed. Grosfeld-Tressel (2001) reports positive association between competition and TFP growth, Carlin, Fries, Schaffer, and Seabright (2001) report negative relation between domestic competition and new product innovation, and positive relation between foreign competition and innovation, and, finally, Aghion, Carlin and Schaffer (2002) find an inverse U-shape relationship between competition and new product innovation. The latter result is supported in the Jefferson et al. (2002b) study of the R&D performance of Chinese firms.

Aghion, Carlin and Schaffer (2002) study interaction between competition and firm leverage or corporate governance, hard budget constraints or credit rationing. The theoretical part of the paper shows that in the Aghion-Dewatripont-Rey (1999) model (ADR), where managers do not maximize profit, but care about their own survival, the effect of competition on innovation decreases with increase in managerial claims on monetary profit or higher debt pressure, because these factors work as substitutes to competition in their effect on managerial incentives. In step-by step innovation model of the type of Aghion, Harris, Howitt and Vickers (2001) model (AHHV), competition and managerial claims on profit or hard budget constraints are complements. The interaction between competition and credit rationing in AHHV model is nonlinear. When competition is not too strong, and, therefore, financial constraints are not binding, increase in competition enhances innovation. However, when competition increases, Shumpeterian-type effects start to work, i.e. competition starts to exert negative influence on innovations through the negative effect on profit. The empirical part of the paper demonstrates dramatic differences between the effect of competition on new and old firms. While new firms innovate more than the old ones, competitive pressure boosts innovations on both types of firms. Foreign competition is particularly important for the old firms. Soft budget constraints are detrimental to innovations. Similar finding, although using the same dataset, was obtained in Carlin et al (2001). New firms are significantly less likely to innovate when they face more than one competitor. Since new firms are usually considered as more budget-constrained, this finding is consistent with the hypothesis that ADR model is more relevant for the old firms, while AHHV model is more relevant for the new firms.

Several papers study the effects of ownership structure on firms restructuring and innovation performance in more details. Carlin et al (2001) show that state-owned firms innovate less than the privatized and new firms, although fails to find differences in introduction of new products by privatized and new firms. Jefferson et al (2002a) show that introduction of new product on Chinese firms is more or less the same for all ownership categories, with the exception of overseas and foreign firms. Among these two groups of firms, the proportion of firms, which is involved into introduction of new products, is rather small. In fact, such firms also spend less on R&D, which may suggest that they rely on headquarters in their innovative activates. Importantly, those overseas and foreign firms, which introduce new products, do it with significantly higher intensity, than average Chinese firms. It is also interesting to report the results of Grossfeld and Tressel (2001) paper, although they are not directly related to innovative activities. This paper finds non-linearity in performance of Polish listed firms with ownership concentration: firms with dispersed ownership and with the concentrated one are more productive than the firms with intermediate concentration of ownership.

Two other factors, effect of which on innovations is interesting to study in a transition economy, are corporate governance and quality of management. Throughout 1990s Russian companies were famous for bad quality of corporate governance. The major goal of managers and some groups of outside owners was to get control over companies, and they used all possible means to fulfill this goal. At the beginning of the 2000s, this process of ownership consolidation was finished, and owners started to pay more attention to capitalization of their companies. As a way of influencing capitalization, the companies started to pay more attention to improving relationship with minority shareholders. Many companies adopted new codes of corporate governance, started to produce accounting reports prepared using international rules, introduced independent directors into their board, and so on. This process started on some of the large companies, but it quickly spread into a number of smaller companies (Guriev et al, 2003). There are at least two reasons why owners of Russian companies started to behave in this way. The first one is that they decided to cash in the results of privatization, and attempted to increase capitalization of their companies in order to increase the price of these companies in their future sales. The second reason is that they needed to rise funds for investments, and they had to improve corporate governance in order to decrease the costs of such funds. These two different hypothesis map themselves into two different strategies regarding innovations. Clearly, in the second case, when good corporate governance is a way to attract investments, corporate governance should be positively correlated with innovations. Owners of firms, which follow such strategy, care about current and future profitability of their firms, and make investments to increase profitability. Most likely, such increase in investments results in innovations or at least in imitations. In the first case scenario, the sign of the correlation coefficient between the quality of corporate governance and innovation activities is not so easy to predict. If innovations are expensive, and owners would like to sell of their firms quickly, firms are unlikely to conduct innovations. On the other hand, some cheap incremental innovations can still be undertaken, because they can also lead to improvement of capitalization of the firm and increase in its current profit.

Apart from other factors, quality of management can have substantial influence on incidence and form of innovation activities of enterprisers. Soviet managers were not used to changing production profile in order to suite the interests of consumers and to maximize profit. Instead, their major goal was fulfilling production plans. There is a substantial literature on economics of planned economies, which argue that this goal was inconsistent with renovation of enterprisers and introduction of new technologies and products on old firms. Renovations and other changes took time, thus not allowing firms to produce more goods to fulfill plans. This lead to problems in commercialization of R&D results, which were widespread in the Soviet Union. Most of innovations were installed on absolutely new plants, while the old ones continue to produce outdated output. Because of resource constraint, rate of innovations in such economy was quite low. In addition to this improper alignment of incentives, Soviet managers had no marketing skills. Soviet firms did not have to care whether consumers like their products or not. The wholesale and retail trade sectors were separated from production, and producers did not get enough signals from consumers. Producers did not care whether the good is sold to the final consumers; they only cared about fulfilling production plan.

Although transition from plan to the market economy has clearly changed the incentives of producers; managers’ skills have not automatically changed. Therefore, one can imagine that firms innovate too little because their managers do not know how to find or design the product, which will be popular among consumers, and how to advertise it and more generally how to sell it to consumers in the most efficient way. Innovations may appear to be too expensive, and too risky process for such managers, and they will under-innovate as a result. In addition to decrease in the overall innovation rate, poor quality of management can result in bias toward imitations, which may look as a safer bet for under-qualified managers.