Global value chains, financial constraints, and innovation

This paper analyzes the effect of firms engaging in global value chains (GVCs) and suffering from financial constraints on innovation. To explore this relationship, this study relies on firm-level data from World Bank Enterprise Surveys (WBES) for 146 countries during the period between 2006 and 2020. The aim of this paper is to empirically link two literature strands, the one of GVC participation and that of financial constraints, and to examine their individual effects, in addition to the effect of their interaction on innovation. Extended probit model is used to account for the endogeneity problem that may arise when studying the effect of GVC participation and financial constraints on innovation, by using a set of instrumental variables. This paper controls for heterogeneity among firms (by country, region, and industry), firms' characteristics, reverse causality, and sample selection. The results of this paper show that financial constraints impede firms' probability of innovation even if the firm is participating in GVC. This means that the negative effects of financial constraints outweigh the positive effects of GVC participation on innovation. Plain English Summary The main findings show that firms that are jointly financially constrained and participants in GVCs have lower probability of innovation. This implies that the negative effects of financial constraints outweigh the positive effects of GVCs on innovation. This study has important policy implications. Governments should use several policies to encourage firms' participation in GVCs and to ensure they have better financial structure. Therefore, policymakers may facilitate lending and financing procedures by providing financial assistance or offering loans with easier terms. However, this strategy should not neglect a careful screening and monitoring process. Moreover, governments may provide tax incentives, such as R&D tax allowance or R&D tax credit incentives, to nascent participants in GVCs to encourage them to innovate. They may also incentivize firms to increase their investments in innovation by lowering tax rates on firms with worldwide recognized innovations. Finally, governments may as well provide non-financial assistance to firms in form of trainings and assistance programs.

Automated summary

This paper analyzes the impact of firms' engagement in global value chains (GVCs) and financial constraints on innovation. The results demonstrate that financial constraints have a greater negative effect on innovation than the positive effect of GVC participation.