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Is globalization damaging innovation? | The capital

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Is globalization damaging innovation? | The capital

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Parent companies need to retain the knowledge created in their subsidiaries in order to benefit from globalization

Globalization promotes innovation, so the conventional wisdom. But new evidence suggests that this assumption, like so many economic buzzwords, needs to be reconsidered.

The conventional wisdom is based on a 1991 study by Gene M. Grossman and Elhanan Helpman that showed that by creating larger, more integrated markets, globalization promotes efficiency, promotes specialization, and increases the incentive for for-profit entrepreneurs to do research investing and development (R&D). The result was an increase in the global rate of innovation.

However, recent research on China’s global impact shows that the relationship between globalization and innovation is not that clear-cut. On the one hand, Nicholas Bloom and his colleagues note that increased competition from China has contributed to an increase in patents in Europe. On the other hand, David Autor and his colleagues point out that the “China shock” has reduced the rate of innovation in the USA.

What explains these different results? One possible answer lies in changes in manufacturing.

Most innovations traditionally take place in production. But in rich countries – especially the US – manufacturing’s share of output and employment has been declining for decades as multinational companies have relocated labor-intensive production to low-wage countries like China or Eastern European countries. If innovation takes place where production takes place, it makes sense that China’s rise as a production location goes hand in hand with falling innovation in a country like the USA.

But this result is not inevitable. Whether or not the loss of production jobs undermines innovation depends largely on the way a multinational company is organized – in particular on the connections between the production and innovation sides of the company.

If the performance of a company depends on the personal interaction between both sides, manufacturing and innovation activities should be located in close geographical proximity. Otherwise, innovation is likely to decline. This is often the case with US firms: subsidiaries that are further away from their parent company tend to have fewer patents.

However, when managers facilitate and direct the flow of information between these two groups of workers, the geographic location of the two activities may be less important. This would support innovation in advanced economies, even if manufacturing takes place on the other side of the world.

My research examining the migration of manufacturing jobs to Eastern Europe after the fall of communism confirms this reading. In the 1990s, Eastern European countries had low per capita incomes but were rich in skills, especially engineering. That made them ideal environments for low-cost innovation.

Germany and Austria particularly liked that – both were significantly more affluent, located nearby and faced with an acute shortage of skilled workers. In the following years, German and Austrian companies not only relocated jobs in production, but also activities that required special skills and important research to Eastern Europe.

From 1990 to 2001, Austrian subsidiaries in Eastern Europe employed five times as many people with academic degrees in terms of staff as their parent companies. They also had 25% more research staff in their laboratories. Likewise, German subsidiaries in Eastern Europe employed three times as many workers with academic degrees and 11% more researchers than their parent companies.

But there was a big difference between German and Austrian multinationals. German multinational corporations transferred the organizational structure of the company to the subsidiaries in Eastern Europe and sent German managers. This made it possible to ensure that the knowledge generated in the Eastern European research laboratories flows back into the parent company, which thus had more control over the innovation.

In contrast, Austrian multinationals – mostly subsidiaries of foreign companies themselves – adapted the organizational structure of their Eastern European subsidiaries to the local environment and hired more local managers. As a result, their subsidiaries were more autonomous in their innovation decisions. No mechanism has been put in place to ensure that the knowledge generated in the subsidiary is also used by the parent company.

In the past ten years, Germany has generally developed economically, while Austria has suffered from low growth rates and high unemployment. Austria’s struggles may have their origin in the reverse pattern of specialization in innovation with Eastern Europe. The qualification level in Austria, measured by the proportion of people in employment with a university degree, was 0.07 in 1998 compared to 0.14 in the Central European countries.

As Germany has shown, innovation does not depend on physical production. In addition, declining innovations in manufacturing can be at least partially offset by increased R&D in other sectors. It happened in the US: in 2016, manufacturing accounted for only 54% of US patents and 59% of R&D spending – up from 91% and 99% in 1977, respectively, while non-manufacturing companies account for 46% of all US patent grants.

But manufacturing and innovation still complement each other. And as the very different experiences in Austria and Germany show, offshoring production alone does not necessarily undermine innovation. When parent companies implement mechanisms to acquire the knowledge created in their sister companies, they can take advantage of globalization – including offshoring – without losing innovation.

Dalia Marin is Professor of International Economics at the Faculty of Management at the Technical University of Munich and a research assistant at the Center for Economic Policy Research.

Copyright: Project Syndicate

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