Foreign market size and firm innovation evidence for developing countries manufacturing firms

Abstract

Utilizing data for developing countries manufacturing rms we construct and estimate the impact of an exogenous foreign market size measure on rm inno- vation on the extensive margin. Our data allows us to di erentiate between innovative outputs, that is innovation through the introduction of new/improved products or production processes. We nd an overall positive impact of foreign market size on a rms probability to innovate in both dimensions. This e ect is more prominent for product innovation. We also nd di erent heterogeneous e ects. First, we nd that rms atop the productivity distribution are more likely to innovate via products when foreign demand expands. Our evidence also suggests that accessing foreign markets spurs innovation. Given that entering foreign markets is costly we nd evidence that in countries with better credit availability rms innovate more on the product dimension when world demand increases and that for introducing new processes an industry's dependence of external funds reduces this type of innovation. One key di erence between our ndings and previous literature for developed countries is that we nd an aver- age positive e ect of the foreign demand shocks. Our results are consistent with a dominance of the escape competition e ect over the rent dissipation e ect.