Multinational firms and the location of innovative activity November 2008 UK technology performance, multinational firms and the location of innovative activity Laura Abramovsky Rachel Griffith Helen Miller Institute for Fiscal Studies and UCL

Multinational firms and the location of innovative activity November 2008 Long standing policy concern about poor UK R&D performance Business expenditure on R&D as % GDP

Multinational firms and the location of innovative activity November 2008 Long standing policy concern about poor UK R&D performance Business expenditure on R&D as % GDP

Multinational firms and the location of innovative activity November 2008 Long standing policy concern about poor UK R&D performance Business expenditure on R&D as % GDP

Multinational firms and the location of innovative activity November 2008 Long standing policy concern about poor UK R&D performance Business expenditure on R&D as % GDP

Multinational firms and the location of innovative activity November 2008 Industrial Restructuring Has movement towards less R&D intensive service sector contributed to poor performance? Has played a role –Service sector accounts for increasing share of value added –and is less R&D intensive –Timing different across countries However: –Manufacturing has become more R&D intensive –Decomposition shows industrial composition doesn’t explain everything

Multinational firms and the location of innovative activity November 2008 R&D performance data -activity based within geographical boundaries of UK But firms operate globally –Traditionally think of services being immobile –Increased trade in services –Recent falls in transport and communication costs –More activity moving offshore OECD: On average, 16% of all inventions filed at the EPO listed inventors in different countries to that of applicants (firms) in increase from the level of 10%. UK R&D performance

Multinational firms and the location of innovative activity November 2008 Firms are key: –New trade theory emphasises role of firms in macro outcomes –Firms make decisions over prices, locations etc & respond to changing incentives –Need to understand firm behaviour to understand trade flows Heterogeneity in firm behaviour Firms’ decisions

Multinational firms and the location of innovative activity November 2008 This talk The data Multinational activity: descriptive statistics –extensive and intensive margins Is innovative activity abroad is substituting for innovative activity in the UK? Where firms are locating? A few comments

Multinational firms and the location of innovative activity November 2008 Data UK multinational - HQ UK subsidiary -production -R&D German subsidiary -R&D Spanish subsidiary -production

Multinational firms and the location of innovative activity November 2008 Data Location and scale of innovative activity come from inventor location on EPO patents UK multinational - HQ UK subsidiary -production -R&D German subsidiary -R&D Spanish subsidiary -production

Multinational firms and the location of innovative activity November 2008 Patent example

Multinational firms and the location of innovative activity November 2008 Data Ownership structure comes from firm accounts (Amadeus); patent applicants are linked to subsidies, which are then matched to ultimate parent firm UK multinational - HQ UK subsidiary -production -R&D German subsidiary -R&D Spanish subsidiary -production

Multinational firms and the location of innovative activity November 2008 Patent example

Multinational firms and the location of innovative activity November 2008 Data Innovative activity - inventors listed on patents owned by the parent firm –inventors are proxy for innovative activity, embody knowledge –consistently measured and comparable across countries –provides location of activity Ownership structure - accounts data –Match using name matching algorithm –Identify parent firms of subsidiaries Industry of activity –Derwent Innovation Index (Thomson) classify each patent according to the use of the technology

Multinational firms and the location of innovative activity November 2008 Data Innovative activity - inventors listed on patents owned by the parent firm –inventors are proxy for innovative activity, embody knowledge –consistently measured and comparable across countries –provides location of activity Ownership structure - accounts data –Match using name matching algorithm –Identify parent firms of subsidiaries Industry of activity –Derwent Innovation Index (Thomson) classify each patent according to the use of the technology

Multinational firms and the location of innovative activity November 2008 CountryNo. patents with corporate applicant No. corporate applicants No. matched % matched Weighted % matched UK75,75714,49510, DE296,32326,81414, NL55,8415,3822, FI14,8691,9961, SE29,3895,2382, BE12,9072,1291, NO3,8541, ES5,4612,4341, DK9,5322,3631, IT46,68812,5776, FR112,66615,1845, Data Issues: How good is the match?

Multinational firms and the location of innovative activity November 2008 CountryNo. patents with corporate applicant No. corporate applicants No. matched % matched Weighted % matched UK75,75714,49510, DE296,32326,81414, NL55,8415,3822, FI14,8691,9961, SE29,3895,2382, BE12,9072,1291, NO3,8541, ES5,4612,4341, DK9,5322,3631, IT46,68812,5776, FR112,66615,1845, Data Issues: How good is the match?

Multinational firms and the location of innovative activity November 2008 CountryNo. patents with corporate applicant No. corporate applicants No. matched % matched Weighted % matched UK75,75714,49510, DE296,32326,81414, NL55,8415,3822, FI14,8691,9961, SE29,3895,2382, BE12,9072,1291, NO3,8541, ES5,4612,4341, DK9,5322,3631, IT46,68812,5776, FR112,66615,1845, good ok Data Issues: How good is the match?

Multinational firms and the location of innovative activity November 2008 Data Innovative activity - inventors listed on patents owned by the parent firm –inventors are proxy for innovative activity, embody knowledge –consistently measured and comparable across countries –provides location of activity Ownership structure - accounts data –Match using name matching algorithm –Identify parent firms of subsidiaries Industry of activity –Derwent Innovation Index (Thomson) classify each patent according to the use of the technology

Multinational firms and the location of innovative activity November 2008 Datasummary UK multinational - HQ UK subsidiary -production -R&D German subsidiary -R&D Innovative activity – inventors data Ownership structure – accounting data Industry structure – classification by use of technology Inventor locations

Multinational firms and the location of innovative activity November 2008 Innovative activity conducted offshore by multinationals resident in each country (% total activity)

Multinational firms and the location of innovative activity November 2008 Innovative activity conducted offshore by multinationals resident in each country (% total activity)

Multinational firms and the location of innovative activity November 2008 Innovative activity conducted offshore by multinationals resident in each country (% total activity)

Multinational firms and the location of innovative activity November 2008 Innovative activity conducted offshore by multinationals resident in each country (% total activity)

Multinational firms and the location of innovative activity November 2008 Firms’ decisions Extensive margin –Firms decisions to locate activity offshore –Probit model Intensive margin –How much activity located offshore –Regression

Multinational firms and the location of innovative activity November /2002Home only Home& Abroad Abroad only UK FR DE SE NL NO A large % of multinationals still do R&D only at home; for some countries a growing % do it only abroad % of multinationals and where they do R&D Firms’ decisions - heterogeneity

Multinational firms and the location of innovative activity November 2008 Extensive margin: how does the propensity to offshore vary? Estimate probit model: Pr(some activity offshore) = f(MNE parent country; industry; firm size) All figures use Germany as a baseline

Multinational firms and the location of innovative activity November 2008 Extensive margin: are there differences across countries? Estimate probit model: Pr(some activity offshore) = f(MNE parent country; industry; firm size) Dep var: (foreign activity)123 French Multinational [0.032]** [0.012]** UK Multinational [0.030]**[0.029]**[0.010]**...plus other countries Industry effectsyes firm size [0.004]** All figures use Germany as a baseline

Multinational firms and the location of innovative activity November 2008 Extensive margin: are differences driven by industrial composition? Estimate probit model: Pr(some activity offshore) = f(MNE parent country; industry; firm size) Dep var: (foreign activity)123 French Multinational [0.032]** [0.012]** UK Multinational [0.030]**[0.029]**[0.010]**...plus other countries Industry effectsyes firm size [0.004]** All figures use Germany as a baseline

Multinational firms and the location of innovative activity November 2008 Extensive margin: does firm size play a role? Estimate probit model: Pr(some activity offshore) = f(MNE parent country; industry; firm size) Dep var: (foreign activity)123 French Multinational [0.032]** [0.012]** UK Multinational [0.030]**[0.029]**[0.010]**...plus other countries Industry effectsyes firm size [0.004]** All figures use Germany as a baseline

Multinational firms and the location of innovative activity November 2008 Probability of locating some activity offshore, by country, relative to Germany All figures use

Multinational firms and the location of innovative activity November 2008 All figures use Probability of locating some activity offshore, by country, relative to Germany

Multinational firms and the location of innovative activity November 2008 Probability of locating some activity offshore, by industry, relative to other industries All figures use

Multinational firms and the location of innovative activity November 2008 All figures use Probability of locating some activity offshore, by industry, relative to other industries

Multinational firms and the location of innovative activity November 2008 Firms’ decisions Extensive margin –Firms decisions to locate activity offshore –Probit model Intensive margin –How much activity located offshore –Regression

Multinational firms and the location of innovative activity November 2008 Estimate regression: Share activity offshore = a*(MNE parent country) + b*(industry) + c*( firm size) All figures use Germany as a baseline Intensive margin: how does the amount invested offshore vary?

Multinational firms and the location of innovative activity November 2008 Share activity offshore = a*(MNE parent country) + b*(industry) + c*( firm size) Dep var: (foreign activity)123 French Multinational [0.038]** UK Multinational [0.031]**[0.030]**...plus other countries Constant [0.019]***[0.024]**[0.021]** Industry effectsyes firm size [0.0025]** All figures use Germany as a baseline Intensive margin: how does the amount invested offshore vary?

Multinational firms and the location of innovative activity November 2008 Share activity offshore = a*(MNE parent country) + b*(industry) + c*( firm size) Dep var: (foreign activity)123 French Multinational [0.038]** UK Multinational [0.031]**[0.030]**...plus other countries Constant [0.019]***[0.024]**[0.021]** Industry effectsyes firm size [0.0025]** All figures use Germany as a baseline Intensive margin: how does the amount invested offshore vary?

Multinational firms and the location of innovative activity November 2008 Intensive margin Additional share offshore relative to Germany (conditional on being offshore)

Multinational firms and the location of innovative activity November 2008 So far… UK firms more likely to have some activity offshore than firms from some other countries – notably the large European countries. Not explained by industry composition Firm size is important -large firms more likely to have activity offshore Propensity to offshore varies by industry Share of activity located offshore varies by country – UK at higher end but not so different

Multinational firms and the location of innovative activity November 2008 Is offshore activity displacing home activity? Growing literature investigating similar question for production activity (largely in US); mixed results Policy concern Not obvious that innovation at home and abroad would be substitutes: –Wrong counterfactual – activity may not have happened at all –Complementarities between locations- e.g. different stages of research; technology sourcing Substitutes or complements?

Multinational firms and the location of innovative activity November 2008 Substitutes or complements? Ideally: estimate factor demand equation consider total labour used by firm i to be a CES-type aggregate of the quantity of labour used in each of j locations gives us the Allen elasticity L: number of inventors e: productivity shocks

Multinational firms and the location of innovative activity November 2008 Substitutes or complements? Estimate: Don’t have relative factor prices across countries Working on getting skilled wages

Multinational firms and the location of innovative activity November 2008 Instead: we estimate the quantity cross-elasticity This is the responsiveness of domestic innovation to change in foreign innovation where L k : domestic inventors, L l : foreign inventors Substitutes or complements?

Multinational firms and the location of innovative activity November 2008 where i: parent firms; j: industries; t: time period L k : domestic inventors, L l : foreign inventors likely that L ilt and e are not independent: use Instrumental Variables estimator Substitutes or complements? Reduced form:

Multinational firms and the location of innovative activity November 2008 Instruments Use factors that vary at both the country and the country industry level- –Country (Z1): government expenditure on R&D and on higher education (HERD and GOVERD intensity), GDP, number of students graduating with college degrees (or equivalent), number of researchers; –Country industry (Z2): level of patenting activity of domestic firms (in foreign location)

Multinational firms and the location of innovative activity November 2008 Instruments Combine with variation in firm-industry-location (at start of period) W ijc is the share of firm i’s foreign activity in country c, industry j at the start of the period

Multinational firms and the location of innovative activity November 2008 Growth in innovative activity at home and abroad

Multinational firms and the location of innovative activity November 2008 Estimates Dep var: ln(dom innov activity)IV ln(for innov activity (0.024)(0.059) industry-time effectsyes parent firm-industry effectsyes obs4734 parent firms426 parent firm-industry1578 Positive coefficient says that more innovative activity offshore is associated with more innovative activity at home

Multinational firms and the location of innovative activity November 2008 Traditional view cites substantial benefits from having researchers located in country – externalities Knowledge moves with increasing ease Benefits from locating offshore –technology sourcing: firms benefit in production from accessing frontier technology offshore –may be complementarities in innovation itself –related to where firms locate Is location important?

Multinational firms and the location of innovative activity November 2008 Location of Innovative activity (%) UKFranceGermanyRest EU15USOthersTotal UK MNEs French MNEs German MNEs Location of innovative activity; 1999/2002 Where are multinational offshoring?

Multinational firms and the location of innovative activity November 2008 Location of Innovative activity (%) UKFranceGermanyRest EU15USOthersTotal UK MNEs French MNEs German MNEs Location of innovative activity; 1999/2002 Where are multinational offshoring? US has been an important host of the activity of European firms, especially UK firms

Multinational firms and the location of innovative activity November 2008 Location of Innovative activity (%) UKFranceGermanyRest EU15USOthersTotal UK MNEs French MNEs German MNEs Location of innovative activity; 1999/2002 Where are multinational offshoring? Germany an important location for French MNEs Other EU15 important for UK MNEs

Multinational firms and the location of innovative activity November 2008 Where do UK firms locate innovation? UK firms invest relatively high share of activity in Germany, Netherlands Sweden,

Multinational firms and the location of innovative activity November 2008 Where do German firms locate innovation? German firms invest high share of activity at home

Multinational firms and the location of innovative activity November 2008 Where do French firms locate innovation? French firms invest high share of activity in Germany

Multinational firms and the location of innovative activity November 2008 Summary UK multinationals among those more likely to offshore activity –not overwhelmingly different From descriptive statistics doesn’t seem that offshore activity is coming at expense of domestic activity Firms operate in a variety of locations – may be related to resulting benefits to countries.

Multinational firms and the location of innovative activity November 2008 Further work on identifying complementarity / substitutability What's happening to domestic activity –activity by domestic firms and by individuals and institutions –activity by foreign multinationals Understand why firms chose certain locations –Market access, tax, regulation, techonology sourcing, skills, science base More rigorous models of firm behaviour Discussion: ongoing work

Multinational firms and the location of innovative activity November 2008 END