8 Absorptive capacity and exporting and importing decisions
An application for developing economies
Abstract
This chapter is intended to provide empirical evidence on the relationship between technological innovation and international trade using firm-level panel data in Egypt to study the dynamics of the relationship between participation in international trade markets and absorptive capacity. In order to do so, we take the technological innovation process as absorptive capacity and consider two facets of technological innovation: creation and absorption. Our results show that both creative and absorptive capacity has an important effect on the decision to trade in developing countries.
Introduction
Technological innovation is acknowledged as an important determinant of trade and competitiveness. However, the specific effect on trade of the different dimensions of the innovation process, namely creation and absorption, has only recently been explored (Márquez-Ramos and Martí;nez-Zarzoso, 2010).
This chapter studies to what extent creation and absorption determine international market participation. We focus on developing countries, as absorption is more important for them because developing countries usually import new technologies from developed countries (Seker, 2009). Using a panel of manufacturing firms in Egypt, we explore the links between the absorptive and creative capacity of firms and their participation in international markets by distinguishing between the determinants of the decision to export and import. The main source for our data is the World Bank Enterprise Survey dataset, which includes information for a representative number of firms in developing countries concerning their production processes, innovative capacity and internationalization, among others. The dependent variable is the decision to export (and import) to (from) a given foreign market, and the main explanatory variables used as proxies for absorptive capacity are in line with the four dimensions in Zahra and George (2002), and used in Márquez-Ramos and Martí;nez-Zarzoso (2010) at country level to analyse the effect of absorptive capacity on exports; namely knowledge acquisition and assimilation (potential absorptive capacity), transformation and exploitation capabilities (realized absorptive capacity). At firm level, we link potential absorptive capacity to absorptive capacity in a narrow sense, whereas absorptive capacity in a broad sense, or creative capacity, is associated with realized absorptive capacity. We find that both the creation and absorption of technological innovation are important when deciding whether or not to participate in international markets in Egypt.
The rest of chapter is structured as follows. The next section presents a review of the literature, and the following section highlights the main hypotheses. Then we describe the data and present the estimation strategy and the main results. The final section concludes.
Literature review
The aim of this chapter is to test whether the creation and absorption of technological innovation play an important role in the decision to enter international markets. This is an old issue in international economics that has been analysed for decades. There is a large body of literature, which partly emerged from the endogenous growth models in the late 1980s/early 1990s (Rivera-Batiz and Romer, 1991) and which views international trade as a vehicle for technology diffusion (Keller, 2004). There are also more recent studies emphasizing interdependence between the decision to enter foreign markets and investments in technology and innovation (Aw et al., 2007; Aw et al., 2008 and 2009; Andersson et al., 2008; Lileeva and Trefler, 2007; Greenaway and Kneller, 2007). The papers on ‘learning by exporting’ (Andersson and Lööf, 2009) constitute another stream of literature that has a bearing on the topic.
Cohen and Levinthal (1990) introduced the concept of absorptive capacity, which is the ability to recognize the value of new, external information, assimilate it and apply it. These authors consider two aspects of technological innovation: creation and absorption. In their model, a certain level of absorptive capacity is necessary to create, and the cost of adoption increases as absorptive capacity decreases. Hence, technological innovation is considered to reduce the cost of adoption. Zahra and George (2002) distinguished not only two subsets (potential and realized absorptive capacity), but also four dimensions of absorptive capacity: acquisition, assimilation, transformation and exploitation capabilities. Knowledge acquisition and assimilation capabilities make up potential absorptive capacity, whereas knowledge transformation and exploitation form realized absorptive capacity. Their model highlights external sources of knowledge and experience as key precedents of absorptive capacity. Along these lines, the learning process will result in technological innovation having an ambiguous effect on exports that will affect the capacity of the firm to acquire, assimilate, transform and exploit new external information. On the one hand, the more ‘experience’ in techniques gained by using them, the greater the rate at which these techniques become more productive. On the other hand, international transmission of new techniques entails a cost because learning-by-doing must occur locally in order to reduce local costs. Hence, the learning process must be taken into account to analyse the relationship between technological innovation and exports. This relationship could differ significantly depending on the specific component of technological innovation considered.
In previous research at country level, Márquez-Ramos and Martí;nez-Zarzoso (2010) hypothesize that developing countries may need a minimum level of technological innovation to obtain trade gains derived from higher technological innovation achievements, whereas the level of technological innovation already achieved in developed countries is sufficient to obtain trade gains from technological innovation developments. The authors find that different levels of technological innovation are linked to different effects on exports in developed and developing countries, owing to the existence of threshold effects in the relationship between technological innovation and trade.
At firm level, a number of authors have already analysed the effect of technological innovation on the decision to export. Aw et al. (2008) find that firm heterogeneity in productivity is crucial when explaining differences in exporting choices for Taiwanese firms. For the case of Latin America, Estrada et al. (2006) focused on the decision to export to a given market using a panel of 1,087 Mexican manufacturing firms and found an inverted ‘U’ relationship between some variables related to technological innovation (structural characteristics – size, age and foreign capital intensity – technological acquisition – machinery and equipment, technological services – and innovative results – new products, product improvements and diversification) and the probability of exporting. They also found R&D intensity to have a U-shaped effect on export probability, implying that companies with very low or very high R&D intensity are more likely to export than those with medium R&D intensity. Using a firm-level dataset for Argentina, Castagnino (2010) analyses what drives geographical diversification in international markets. The author finds it to be more likely for an Argentinean firm to enter a particular market when it has already exported to a country at a similar stage of development in the past. In addition, the likelihood of holding a quality certificate is positively related to the income of the destination market. Furthermore, Castagnino (2010) finds that firms that export to ‘easier’ markets, such as Mercosur,1 are less likely to comply with ISO standards. This result is in line with the literature that relates trade openness to firm performance, and shows that firms that are engaged in international trade are more productive than firms that serve only domestic markets (Bernard et al., 2007). Moreover, the fact that a firm holds an internationally recognized quality certificate could also be used as a measure of the degree of implementation of technological innovation, as in Seker (2009).2 Therefore, the results obtained in Castagnino (2010) provide evidence that greater technological innovation leads to higher export diversification and firms exporting to higher income destinations. However, these papers do not consider the decision to import.
To the best of our knowledge, Seker (2009) was the first study to explore the link between technological innovation and the decision to export in developing countries, as well as the decision to import. The framework used by Seker (2009) analyses whether or not firms that export and/or import are more engaged in technological innovation. However, it is well known that causality could also work in the opposite direction; that is, firms that display higher levels of technological innovation are more likely to start exporting or importing or, what is even more probable, there may be a factor affecting both participation in international markets and also technological innovation. This research focuses exclusively on how technological innovation per se affects the decision to trade with foreign partners in a North African developing country.
Main hypotheses
On the one hand, our first hypothesis is that the relationship between technological innovation and trade decisions differs depending on the proxy used to measure technological innovation at firm level. In a national-level analysis, Márquez-Ramos and Martí;nez-Zarzoso (2010) measured acquisition, assimilation, transformation and exploitation capabilities as different dimensions of the Technological Innovation Achievement index (UNDP, 2001), namely creation, diffusion of old innovations, diffusion of recent innovations and human skills, respectively. In keeping with this, we consider four different dimensions of absorptive capacity at firm level and test whether they have a differential effect on firm trade decisions in developing countries. Our results support this first hypothesis, and proxies used for absorptive capacity and creative capacity are found to be positive and significant across specifications.
On the other hand, our second hypothesis states that the effect of technological innovation differs between exporting and importing decisions. Importing and exporting decisions can lead to enhanced firm performance, as a greater use of foreign inputs can increase firm productivity on account of access to a greater variety of inputs or to these products being of higher quality, whereas exporting increases market size, sales and the likelihood of benefiting from economies of scale. Therefore, technological innovation improvements can increase the likelihood of a firm participating in international markets, either as an exporter or as an importer. In the case of developing economies, we find that the diffusion of technology, and hence assimilation and transformation capabilities, are significant for importing decisions, whereas creation and diffusion of recent innovations (or acquisition and transformation capabilities) are found to be significant for exporting decisions.
Testing these two hypotheses at firm level contributes to the insight in the literature regarding absorptive capacity by providing evidence that the dynamics of creative and absorptive capacity has a differential impact on exporting and importing decisions in developing countries.
Empirical application and main results
Data description
Plant-level data from the World Bank Enterprise Survey dataset is used for the empirical application. Data have been collected for a number of developing countries and a representative random sample of firms belonging to the manufacturing industry is selected from the survey for each country. This chapter focuses on Egypt and a total of 2,316 firms from the manufacturing sector of this economy are used in the analysis. The surveys were conducted in 2004 and 20073 covering 977 and 1,339 firms, respectively (see Table 8.1). In addition to the cross-sectional data, 695 firms were surveyed in both years.
Table 8.2 shows the list of manufacturing industries that are included in the analysis, their importance with regard to the total manufacturing industry and the number of firms in the panel that participate in every industry in the years 2004 and 2007. The last column in Table 8.2 shows the percentage increase (or decrease) in the number of firms in each industry.
In Table 8.3, firms are divided into groups according to their trade orientation. Column 1 of Table 8.3 shows the number of firms importing and exporting in each sector and columns 2 and 3 show the number of firms that only import or export, respectively, in each sector. In most industries the majority of firms only sell locally. In order to isolate ‘export starters’ we will create a dummy in the empirical analysis that takes a value of one if firms start to export in 2004 or 2005.4 This will exclude all firms that export persistently during the period, but enable a stronger statement to be made about causality. Therefore, the fourth column in Table 8.3 shows the number of firms that exported in the previous year. Table 8.A.1 in the Appendix shows the numbers for 2004.
Model specification and variables
We estimate a regression for the export (import) market participation decision as a function of technological innovation variables. The estimated model is given by equation (8.1):
 |
(8.1) |
where subscript i indexes firms; and t, time. EXPDUMit is a dummy variable that takes a value of 1 if firm i exports (imports) in year t, and 0 otherwise. TAIit denotes the technological innovation dimension, namely acquisition, assimilation, transformation and exploitation capabilities, respectively. Xk are a number of control variables commonly used as determinants of the decision to export, namely firm size, productivity, number of workers and age of the firm (see, for example, Greenaway et al., 2007). Finally, we follow Aw et al. (2008) to control for prior export status and deal with the possibility that absorptive capacity may be stimulated by the presence on foreign markets, and then we include a dummy
| Surveys | Number of firms | Panel |
| Egypt 2004 | 977 | 695 |
| Egypt 2007 | 1,339 | 695 |
| Total | 2,316 |
variable that takes a value of 1 if firm i exported the previous year (EXPDUMit−1), as well as an interaction term between each of the TAI dimensions and the EXPDUMit−1.6
Similar to the national-level analysis in Márquez-Ramos and Martí;nez-Zarzoso (2010), we measure acquisition, assimilation, transformation and exploitation capabilities (or dimensions) as creation of technology, diffusion of old innovations, diffusion of recent innovations and human skills, respectively.
Concerning creation of technology, the variable chosen in this empirical analysis is creation. Has the establishment upgraded an existing product line in the factory? This variable is expected to have a positive sign.
We used the log of the cost7 of telephones/communications (old) as a proxy for diffusion of old innovations, which is expected to display a positive sign.
As a proxy for diffusion of recent innovations, we use the answer to the question asking whether the severity of ‘telecommunications’ is an obstacle to the operations and growth of the firm (recent1), which is expected to display a negative sign, and also whether the establishment regularly uses a website to interact with
clients (recent2), which is expected to display a positive sign. Finally, we use the answer to the question: do you offer formal internal training (provided within the walls of your establishment) to your permanent employees? (human) as a proxy for human skills. This variable is expected to display a positive sign as stronger commitment to education and workers undergoing training is expected to raise the likelihood of participating in international trade markets.
Main results
The main results are presented in Table 8.4. Equation 1 has been estimated using a probit model. The first column presents the determinants of the decision to export in 2005 and the second the determinants of the decision to export in 2004, whereas column 3 presents the results when the decision to import in 2005 is the dependent variable. Finally, columns 4 and 5 present the results obtained from isolating ‘export starters’ in the dataset.
As expected, firm size, labour productivity and prior exporting are important determinants of the decision to trade.
Concerning the technological variables, while the proxies used for old innovations and human skills are not statistically significant (old and human), they
do display the expected sign, whereas the proxies used for technology creation (creation) and diffusion of recent innovations (recent2) display the expected positive sign and are statistically significant for the decision to export in 2005. The proxies used for diffusion of recent innovations indicate that this dimension is the most important for sales internationalisation on behalf of Egyptian firms. Furthermore, diffusion of both old and recent innovations are significant and have the expected sign for the decision to import, hence assimilation and transformation capabilities in Egyptian firms do seem to be relevant when deciding to participate in international markets as an importer. These results are also obtained when the firms that export persistently during the period are left out.
Conclusions
This chapter analyses the relationship between technological innovation and international trade using firm-level panel data in Egypt to study the relationship between participation in international trade markets and absorptive capacity. In order to do so, we take technological innovation as creative and absorptive capacity and test two main hypotheses. On the one hand, we analyse whether the relationship between technological innovation and trade decisions differs depending on the proxy used to measure technological innovation at firm level. On the other hand, we test whether the effect of technological innovation differs between exporting and importing decisions. In the case of Egypt (as a developing economy), we find that both creative and absorptive capacities have an important effect on export and import decisions. Further research should focus on the existence of a non-linear relationship between the two facets of technological innovation and trade decisions, as the dynamics of the relationship between both potential and realized absorptive capacities, and a firm's decision to export and/or import, might display a different shape.
Appendix
Notes
1 Mercosur is a free trade area including Argentina, Brazil, Paraguay and Uruguay.
2 Seker (2009) looks at the probability of introducing new products, improving existing processes, having any internationally recognized quality certificates and using foreign-licensed technologies to analyse whether firms implement technological innovation.
3 The questionnaires used in 2007 asked firms about 2005.
4 The dummy takes a value of zero when the firm did not export in the previous year.
5 In our sample, 365 firms exported in the year 2005.
6 The interaction variables are not statistically significant, as in Aw et al. (2008), and are excluded from Table 8.4 to save space. Full results are available from the authors upon request.
7 Value expressed in thousands of Egyptian pounds.
8 In our sample, 188 firms exported in the year 2004.
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