Worker reallocation and firm innovation

April 24, 2021

The extraordinary increase of Chinese exports over the past two decades has represented a new source of competitive pressure for European firms. In this context, innovation and investments in knowledge are considered as a protection against import competition from low-wage countries. Given that wage differences are large and take time to respond, competing on costs is not always a feasible option. This paper examines whether firms in Denmark and Portugal escape import competition through innovation by either internally reallocating their non-R&D workers to R&D jobs, hiring new workers for R&D activities, or doing both.

Using Danish register data, the paper finds that a 100 percent increase in import competition raises the number of patent applications by 7% and the share of R&D workers by 4% on average. Approximately 40 percent of the increase in innovation is attributable to the total increase in the share of R&D workers. Moreover, approximately 14 percent of the increase in the share of R&D workers at the firm level is due to an internal reallocation to R&D jobs, while 80 percent is due to new hirings.

When the analysis is extended to Portugal, the paper finds that relative to Denmark, the increase in firms' R&D worker share and innovation in response to import competition is smaller. Contrary to the Danish results, most of the increase in the share of R&D workers is attributable to the internal reallocation of labor. This result suggests that Portugal’s more stringent labor market regulations and low productivity of firms limit firms' potential adjustment in response to competitive shocks. Furthermore, the increase in the share of R&D workers due to import competition has a weaker relation to firms' innovation in Portugal than in Denmark. This last result corroborates the importance of new hirings for explaining the relationship between import competition and innovation.

Click here to go to the paper by Grace Gu, Samreen Malik, Dario Pozzoli, and Vera Rocha.