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Innovation for Growth – i4g

Policy Brief N°21

Innovative firms in Global Value Chains´

Reinhilde Veugelers

Findings

Global Value Chains (GVC) challenge prevailing policy thinking about competitiveness.

GVCs drive countries interdependence:

- Country's exports increasingly embody technology, labour and capital of other countries by

imports of intermediate goods;

- Imports increasingly reflect tasks which complement, rather than substitute for, domestic

production.

GVC-involved-firms simultaneously organize part of their production abroad, import components for local

production and export their produced goods.

The EFIGE database analysis shows that relatively few GVC firms exist (5%). However, these firms are the bigger

ones, substantially driving value added creation and employment.

These firms matter critically for the innovation performance of countries and sectors. They are more heavily

engaged in R&D activities, have a sophisticated human capital base, hire more workers with a university degree

and are consequently being able to support high unit labour costs. These firms introduce more product

innovations and display the highest productivity premia.

Recommendation

The growing interconnectedness limits the effectiveness of national policies and requires more international (or

EU-level) coordination of policies.

In this context, government intervention should be sufficiently generic, and avoid picking particular sectors to

support. However, it should

- Provide the framework conditions to support a GVC innovation-based growth path for enterprises,

whatever their size, age or sector affiliation;

- Aim at capabilities that support of higher value-added GVC activities;

- Support productive internationalised firms with unique innovative capabilities, having a GVC

strategy which is more than simply exporting.

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REINHILDE VEUGELERS

PROFESSOR AT KULEUVEN, SENIOR FELLOW AT BRUEGEL, MEMBER OF THE I4G EXPERT GROUP

OCTOBER 2013

1. Introduction and motivation

By now a substantial piece of research and evidence has been developed on trends in global value

chains at the aggregate level of economies and sectors (see eg OECD (2013)). What is however still

mostly missing is a robust analysis of the trends and impact of global value chains across sectors and

countries at the level of individual firms. In this contribution, we will exploit the EFIGE database to

look at innovation and global value chains at the firm level1. With its detailed information on

internationalization strategies of firms together with information on their innovative profile and

performance information, EFIGE provides a unique opportunity to analyse GVC involvement, its

impact and relationship with innovation at the firm level.

We first describe how we measure a firm’s involvement in global value chains in the EFIGE dataset.

Section 2 presents the firms which we identify as involved in global value chains. We will show

how concentrated overall value added and employment are in few GVC involved firms. It thus

matters to get to know these few but pivotal firms better. GVC involved firms are also likely to

matter for competitiveness because of their productivity and innovation profile. Section 3 looks at

the performance profile of multiple mode firms, analyzing whether higher GVC involvement is

associated with higher productivity. Section 4 looks at the R&D, human capital investment and

innovative performance of GVC involved firms. Section 5 looks at how vulnerable GVC firms are to

the crisis and how innovative performance helps to shield GVC firms from the crisis. Section 6

summarizes the main findings. Section 7 provides some policy implications.

1 This contribution draws heavily on Veugelers et al (2013). For more detailed information on the EFIGE database, see the various Bruegel Blueprints (The Happy Few and Triggers of Competitiveness) and the EFIGE website (http://www.bruegel.org/datasets/efigedataset/). EFIGE was an FP7 funded project.

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2. Characterizing GVC involvement with the EFIGE Data

The EFIGE dataset is a representative and cross-country comparable sample of firms with

manufacturing activities in Europe. It includes 14.759 firms, around 3000 of which for Germany,

France, Italy and Spain, 2200 for the UK and 500 for Austria and Hungary and covers the crisis period

2007-2009. The EFIGE database provides unique detailed information on various

internationalization strategies of firms, allowing to look at combinations of international strategies

typically associated with GVC involvement: importing of components, offshoring or internationally

outsourcing certain parts of the value chain, exporting finished goods or semi-finished goods for

further processing and trade.

To identify firm’s involvement in GVCs, we look at the complexity of firms’ international strategy, as

reflected in how many international activities they deploy in combination. Low involved firms only

use one internationalization mode. These are typically sole exporters or sole importers (single

moders). Medium involved firms are those firms that substantially combine 2 modes (dual moders):

these are typically firms that simultaneously substantially import components/services and export

their products. High involved firms are those that combine 3 modes: they substantially import

components, substantially export their goods and substantially offshore or (internationally)

outsource parts of their activities (triple moders). Table 1 shows that only 5 % of the sample firms

are triple moders, simultaneously importing, exporting and producing abroad, illustrating the

skewedness of the distribution of GVC involved firms2.

TABLE 1: GVC INVOLVEMENT AND MULTIPLE MODE INTERNATIONALISERS

Number of firms

Share

ZERO Firms without substantial imports, exports, international production

4232 29%

LOW Single Mode

Pure Exporters (3072); Pure Importers (1630); Pure international producers (40)

4742 32%

2 For a more detailed description of the GVC involvement construction and validation, see Veugelers et al (2013).

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MEDIUM Dual Mode

Importers and exporters (4738); International producers and importers (96) or exporters (165)

4999 34%

HIGH Triple Mode

Importers, exporters and international producers (through FDI or international outsourcing)

786 5%

Source: Bruegel calculations on the basis of EFIGE;

The prevalence of triple mode internationalisers varies across sectors. This sectoral distribution cuts

across the high-tech/low-tech divide. It is much higher in Textiles (12%) and Electr(on)ics (10%). It is

also higher in Transport equipment (8.7%) and Chemicals/Pharma (7.6%). Wood & Paper has only

3% of its firms in this category, Food, Drinks & Tobacco is the sector where the smallest number of

firms is triple moders (2%) and where the most firms are not substantially internationalizing (42%).

These sectoral patterns are very much in line with findings from the existing GVC evidence on which

sectors are most involved in GVCs (see eg OECD 2013).

TABLE 2: NUMBER OF FIRMS BY SECTOR AND MULTIPLE MODE INTERNATIONALIZATION

Zero Single Dual Triple

Total 28.7% 32.1% 33.9% 5.3%

Food & Tobacco 42.4% 32.5% 23.0% 2.1%

Textile 19.8% 27.9% 40.7% 11.6%

Wood, Paper, Printing, Furniture 34.4% 35.4% 26.8% 3.4%

Chemical and Pharma 10.1% 31.7% 50.6% 7.6%

Rubber and Plastic 26.9% 32.9% 35.5% 4.7%

Metal, Machinery and Equipment 29.3% 32.2% 34.1% 4.4%

Electrical and Optical equipment 18.7% 29.7% 42.0% 9.6%

Transport Equipment 22.8% 25.0% 43.4% 8.7%

Source: Bruegel calculations on the basis of EFIGE; Veugelers (2013)

The sectoral profile reported in Table 2 remains robust in multivariate analysis, identifying which

firm characteristics are significantly associated with multiple mode use, controlling for the presence

of other determining characteristics. This multivariate (econometric) analysis is reported in

Veugelers et al (2013). With respect to country affiliation, there are no significant differences

between UK, German and French firms being triple mode internationalisers. Spanish firms are less

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likely to have dual and triple moders. Austrian firms are significantly more likely to be triple

moders, c.p.

The multivariate results also show that bigger firms are significantly more likely to deploy more

complex GVC strategies, being dual and triple mode internationalisers. The following table

illustrates that multiple mode firms are indeed the bigger ones. They are even more sizable in terms

of value added compared to employment, reflecting a substantial labour productivity premium for

multiple moders, especially triple moders. This translates into triple moders being able to sustain

higher unit labour costs.

TABLE 3: EMPLOYMENT AND VALUE ADDED AND MULTIPLE MODE INTERNATIONALIZATION

Zero Single Dual Triple

Employment 33 44 97 276

Value Added

(thousands of euros)

1246 2377 7930 20005

Labour Productivity 734 1042 2467 5471

Unit Labour Cost 0.79 0.73 0.73 0.93

Source: Bruegel calculations on the basis of EFIGE; Veugelers et al (2013)

Multiple moders, being the bigger firms, matter substantially for aggregate performance of sectors

and countries, as Figure 1 illustrates. The 5% of firms which are triple moders account for about 27%

of total sample VA and 24% of total sample employment. The group of dual moders (i.e. mostly firms

who simultaneously substantially import and export) representing 34% of total sample firms,

account for 53% of total sample VA and 45% of total sample employment.

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FIGURE 1: SHARE IN NUMBER OF FIRMS, TOTAL TRADE, VA AND EMPLOYMENT OF MULTIPLE MODERS

Source: Bruegel calculations on the basis of EFIGE; Veugelers et al (2013)

3. GVC involvement and Productivity

Are firms who are involved in GVCs the higher productivity firms? We know from the empirical trade

literature that the more productive firms are more likely to sort into exporting and offshoring, as

they can overcome the costs associated with internationalization (Melitz (2003), Helpman,

Melitz&Yeaple (2004)). One can expect this to a fortiori hold for multiple mode firms being

simultaneously involved in exports, imports and location of activities abroad. Only the most

performing firms will be able to overcome the costs and risks associated with multiple mode

internationalisation. At the same time GVC involvement can be expected to increase firm

performance, allowing, if only, for more efficient sourcing and larger market access. It does however

also make GVC firms more vulnerable for external shocks.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Distribution ofFirms

Total Trade Value Added Employment

Triple Mode

Dual Mode

Single Mode

Zero Mode

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Our measure for productivity in this section will be Total Factor Productivity. Total Factor

Productivity (TFP) refers to the estimated productivity of all inputs taken together and it is a

measure of the global efficiency of a firm3. As a 'residual', TFP basically accounts for effects in total

output growth not caused by capital and labour. TFP is commonly interpreted as a measure of the

technology of production and its rate of growth as a measure of technical progress.

Unfortunately, since in the EFIGE dataset TFP is measured simultaneously with the identification of

the internationalization strategy, we can only investigate a possible correlation between productivity

and GVC involvement. We cannot identify any causal relationship, i.e. whether multiple mode

internationalization strategies are making firms more productive or whether more productive firms

select into multiple mode internationalization.

As the distribution of firms along TFP levels is highly skewed, it makes more sense to look at the full

distribution of productivity levels, rather than averages (see also Altomonte et al (2012)).

FIGURE 2. TFP DENSITY AND MULTIPLE MODE INTERNATIONALISERS

Source: Bruegel calculations on the basis of EFIGE; Kernel-density functions; Veugelers et al (2013)

3 For a more elaborate discussion of our productivity measure, see Veugelers et al (2013).

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Figure 2 shows how firms with higher GVC involvements are on average characterized by higher

levels of TFP, particularly the triple mode firms who combine importing intermediates, exporting and

international location of production. The superior performance of these triple moders holds

especially in the upper tail of the distribution, i.e. triple moders are not just more likely to have on

average a higher TFP, they are especially more likely to be the (very) high performers.

Multivariate analysis reported in Veugelers et al (2013), which corrects for other firm and industry

characteristics, confirms a significant and sizeable productivity premium for dual mode and

particularly for triple mode internationalisers. This confirms that GVC firms are more productive not

only because they are typically bigger and older or that they belong to high productivity sectors, but

that their productivity premium is intrinsically connected to their more complex international GVC

involvement, combining several internationalization modes.

4. GVC involvement and Innovation

Is the superior productivity of GVC involved firms, as shown by their TFP premium associated with

being more innovative as driver for their superior productivity? To investigate this in more detail

we look at direct evidence in the EFIGE dataset on the innovative profile of the sample firms. On the

input side, we know the firms’ expenditures on R&D, their employment in R&D activities and the

quality of their human capital base, as measured by the share of university graduates in their

workforce. On the innovation output side, we know whether they introduced any new product

and/or process innovations in the time period considered. This information allows to test more

directly whether GVC involved are more innovative, driving their higher productivity performance.

TABLE 4: INNOVATION INPUTS AND MULTIPLE MODE INTERNATIONALIZATION

Zero Single Dual Triple

% Firms involved in R&D 42% 59% 72% 86%

Share of employees involved in R&D 7.0% 8.1% 8.9% 10.4%

Share of University Graduates in Employment 6.7% 8.6% 11.0% 14.6%

Source: Bruegel calculations on the basis of EFIGE

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Table 4 shows that dual and triple moders are more likely to be involved in R&D activities, having a

higher share of their employers engaged in R&D activities. Furthermore, their human capital base

is more developed, as they hire a larger share of employees with university degrees.

Because of their higher R&D profile and being the bigger firms, triple mode firms account for a

substantial part of overall sample R&D activities. With only representing 5% of the total number of

firms, triple mode firms account for 38% of total sample R&D expenditures, 29% of R&D employees

and 33% of graduates employment. They therefore matter substantially for the overall R&D

performance of sectors and countries.

FIGURE 3: SHARE IN NUMBER OF FIRMS, R&D AND GRAUDATE EMPLOYMENT OF MULTIPLE MODERS

Source: Bruegel calculations on the basis of EFIGE;

Based on their higher deployment of R&D resources and more developed human capital base, triple

mode firms are more likely to introduce product innovations (either sole but particularly in

combination with process innovations) (Table 4). The higher likelihood to introduce process

innovations solely, often associated with introducing cost cutting, labour saving technologies, is

much less pronounced for multiple moders, particularly for the triple moders. All this is consistent

with the story that higher levels of GVC involvement, as evidenced through using multiple

internationalization modes, are associated with higher innovative performance. It does not support

the often claimed adagio that GVC firms are the cost cutting process innovators. This is also

confirmed in multivariate analysis, correcting for other determining factors of innovative

performance (such as R&D and Human Capital inputs).

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Distribution offirms

R&Dexpenditure

R&D employees Graduateemployees

triple

dual

single

zero

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TABLE 4: INNOVATION AND MULTIPLE MODE INTERNATIONALISERS SHARE OF FIRMS HAVING INTRODUCED PRODUCT, PROCESS, BOTH OR NO INNOVATIONS, ROW%

No Innovation Product Process Both

Zero 50% 15% 18% 16%

Single 36% 21% 16% 26%

Dual 24% 24% 14% 37%

Triple 17% 31% 9% 43%

Source: Bruegel calculations on the basis of EFIGE;

BOX 1: Econometric analysis of complexity of international involvement and innovation We look at which firm characteristics significantly correlate with innovative performance in a multivariate fashion. Using a multinomial logit specification, we look at which firm characteristics determine the likelihood for firms to be introducing product innovation, process innovations or the combination of product and process innovations. The multivariate analysis of innovative performance controls for several inputs into the innovation process. It finds that R&D investments increase the probability of innovative performance, for product as well as process innovations. While ICT investments are significant drivers, enabling process innovations, human capital is most associated with product innovations. Our main focus is on the use of a single, dual or triple internationalization mode, the base comparison being firms that have no substantial international activities. Table B.1 displays the results.

Table B.1 : Multinomial logit on Innovation

Dep. Variable: Innovation Performance

Product Only Process Only Product&Process

Single Mode 0.403*** 0.143* 0.437***

(0.07) (0.07) (0.07)

Dual Mode 0.719*** 0.317*** 0.848***

(0.08) (0.08) (0.08)

Triple Mode 1.002*** 0.104 0.936***

(0.15) (0.20) (0.14)

Firm age, fixed firm size effects, intermediate producers, country,

sector dummies, foreign group, foreign competition included as well as

R&D, Human_capital and ICT investments.

Obs 14432;Pseudo R-square 0.108;Chi-square 2877.762

* p<0.10, ** p<0.05, *** p<0.01

The multivariate analysis controlling for other firm characteristics, confirms that firms which are

more GVC involved are significantly more likely to introduce new products, new processes solely or

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in combination. This suggests that innovation can indeed be considered as a likely source for the

higher productivity of GVC involved firms. This holds particularly for dual and triple mode

internationalisers and for product innovations. Firms that combine importing, exporting and foreign

production are particularly more likely to be introducing product innovations, but not sole process

innovations.

5. GVC involvement, Innovation and crisis sensitivity

With the positive association between higher GVC involvement and productivity and innovation,

documented supra, one could expect that their higher productivity profile shields firms with higher

GVC involvement from the crisis, making them less sensitive to the crisis and consequently less likely

to shed jobs. On the other hand, there is also evidence that GVCs act as a channel for the rapid

transmission of real and financial shocks, thus amplifying the national fluctuations of demand for

final goods, making GVC involved firms more crisis-sensitive (cf Altomonte et al., 2012;. OECD 2013)).

With the EFIGE survey it is possible to investigate whether or not firms witnessed a decrease in

turnover between 2008 and 2009 and by how much. Tables 5 show these responses for the different

types of GVC involvement. The descriptive analysis shows that GVC involved firms are somewhat

more likely to have reductions in turnover, but the differences are small.

TABLE 5: MULTIPLE MODERS AND TURNOVER REDUCTION DURING THE CRISIS

Reduction of Turnover in 2009

No

reduction

<10% 10%-

30%

>30%

Zero 31% 20% 31% 18%

Single 28% 19% 35% 18%

Dual 27% 18% 36% 19%

Triple 28% 19% 39% 14%

Source: Bruegel calculations on the basis of EFIGE

The multivariate analysis confirms these statistics. GVC involvement does not significantly correlate

with crisis sensitivity. At the same time and all else equal, the results interestingly show that firms

which invest in innovative strategies are less likely to have seen cuts in turnover or have smaller cuts

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in turnover. This evidence corroborates the assertion that innovation strategies are important for

firm resilience to external shocks.

Box 2: Econometric analysis of the international involvement and sensitivity to the crisis We analyse the firm characteristics conducive to a higher crisis sensitivity in a multivariate fashion using on ordered probit with the categories being: no change in turnover, <10%, 10-30%, > 30% loss in turnover. The use of multiple internationalization modes are our key firm characteristics of interest. Simultaneously we correct for firm size, age, foreign ownership, competition from abroad, intermediate status, as well as sector and country affiliation. We also correct for the presence of inputs for innovation (R&D, Human Capital, ICT). Table B.2 presents the results. Correcting for other firm characteristics, there is no significant difference in crisis sensitivity for single, dual or triple mode internationalisers. A significant driver of crisis resilience is the firms’ strategy in terms of innovation (R&D as a proxy) and human capital: those firms with a higher share of university graduates, a higher share of investment in R&D and ICT are less likely to experience a reduction in turnover or only smaller reductions in turnover.

Table B.2: Ordered Probit on Turnover change during the crisis

Dep. Variable: Turnover change

Single Mode 0.030

(0.03)

Dual Mode 0.031

(0.03)

Triple Mode 0.049

(0.06)

r_d -0.044*

(0.02)

human_capital -0.670***

(0.10)

high_skill -0.142***

(0.04)

ICT -0.060**

(0.02)

Firm age, fixed firm size effects, intermediate status, country, sector

dummies, foreign group, foreign competition included as well

Obs 11152

Pseudo R-square 0.059

Chi-square 1741.147

* p<0.10, ** p<0.05, *** p<0.01

Note: Small firms: 20-49 employees; Medium-sized firms: 50-249 employees; Large

firms: above 250 employees.

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6. Main findings

In this contribution we exploit the EFIGE database to study the prevalence and impact of GVCs at the

firm level, thus further complementing the macro-evidence on GVC involvement, presented in the

literature (OECD (2013). We characterize firms involved in GVCs through the complexity of their

internationalization strategy: GVC involved firms are characterized as “multiple moders” with the

highest involvement firms those that simultaneously organize (part of their) production abroad,

import components for local production and exports their produced goods, which we label as “triple

moders”.

The firm level analysis not only shows the heterogeneity within sectors and countries on GVC

involvement. It also shows the skewedness of performance of sectors and economies towards GVC

involved firms. There are relatively few multiple mode firms, combining different international

activities, particularly triple mode firms that combine importing of components and exporting of

produced goods with organizing part of their production activities abroad. But these few firms are

the bigger firms, substantially driving total value added creation and employment in sectors and

economies. It therefore matters to get to know them better.

Multiple moders, particularly the triple moders, also matter critically for the innovation performance

on countries and sectors. They are more heavily engaged in R&D activities, have a more

sophisticated human capital base, hire relatively more workers with a university degree and are

consequently being able to support higher unit labour costs. They are significantly more likely to

introduce new product innovations, displaying the highest productivity premia. And thanks to their

superior innovative profile, multiple mode firms are not more likely to be crisis sensitive.

Overall, the analysis of global value chain involvement and its impact on performance at the firm

level provides consistent evidence supporting that firms taking on the opportunities of global market

access and global resources sourcing, by combining multiple modes of internationalization,

simultaneously importing components, organizing production abroad and selling their products to

international markets, although perhaps small in number, but with their superior productivity and

innovation capacity profile, are well placed to be engines of Europe’s innovation-based growth,

driving its external competitiveness with globally sustainable comparative advantages. Given their

highly specific position for overall performance, it matters for policy makers to better understand

who they are, what they do and what challenges they face.

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In order to understand them better, more firm-level analysis is needed, particularly tracing GVC

firms over time, to better identify the causal relationship between internationalization strategy and

innovative performance: do firms need to be strong innovators before they can benefit from the

opportunities offered from engaging in global value chains or does engagement in global value

chains turn firms into strong innovative players, being able to wither the gales of fierce global

competition?

7. Some Policy Implications

Global value chains challenge prevailing policy thinking about competitiveness. The growing

upstream and downstream interconnections within GVCs make countries more interdependent: one

country's exports increasingly embody the technology, labour and capital of other countries from

which intermediate goods are imported; imports increasingly reflect tasks which complement, rather

than substitute for, domestic production; the offshoring of a production stage which can be

performed more efficiently abroad makes domestic activities more competitive. This growing

interconnectedness limits the effectiveness of national policies, requiring more international

coordination of policies. For European countries this means first and foremost deeper coordination

at EU level.

For countries to benefit from GVCs, GVCs must become effectively linked to domestic capabilities in

certain tasks. Here a host of national and European economic policies largely determine which

position countries occupy in GVCs: which activities, jobs and what value they are able to create. The

activities to focus on are the higher value-added activities that build on unique and innovative

capabilities. The presence of these activities in Europe will secure productivity growth and external

competitiveness, and retaining them will require having in place the framework conditions that are

most pivotal for these innovative, higher value-added, growth contributing, activities.

Although sectoral idiosyncrasies exist, the challenges and opportunities identified here apply to most

if not all sectors. The shift towards innovative activities is not confined to high-tech sectors and

manufacturing only. Any type of government intervention should be sufficiently generic, and avoid

picking particular sectors to support. What matters most is providing the framework conditions for

viable activities to continue to prosper, and for new activities to develop and grow into leading

world market status, irrespective of in which sector they are classified. What matters more is to

provide the framework conditions to support a GVC innovation-based growth path for enterprises,

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whatever their size, age or sector affiliation. The target should be productive firms with unique

innovative capabilities, which are able to develop an internationalisation strategy that involves more

complex GVC strategies than simply exporting.

The offshoring of routine jobs and the structural shift from classic routine production jobs towards

higher value-added types of jobs that have some of the characteristics of services jobs, has major

implications for employment policy. Although innovative capacity helps firms to shield against

negative shocks, adjustment difficulties are likely to result, because the skill requirements for the

newly created jobs tend to be higher than and different to those for the jobs lost. Effective domestic

policies are therefore needed to reduce the adjustment costs borne by displaced workers. Policies

to pursue, primarily at EU member-state level, include improving the functioning of labour markets

and strengthening education and training.

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References

Altomonte, C., Aquilante, T. and Ottaviano, G. (2012) ‘The triggers of competitiveness: the EFIGE cross country report’, Blueprint no 17, Bruegel, Brussels.

Altomonte, C., Di Mauro, F., Ottaviano, G., Rungi, A. and Vicard, V. (2012), ‘Global Value Chains During the Great Trade Collapse. A Bullwhip Effect?’, European Central Bank Working Paper no 1412.

Mayer T., Ottaviano, G. (2007), ‘The happy few: the internationalisation of European firms,’ Blueprint 3, Bruegel.

Melitz M. (2003), ‘The Impact of Trade on Intra-industry Reallocations and Aggregate Industry Productivity’, Econometrica, Vol. 71, No. 6, 2003, pp. 1695-1725.

Helpman E., Melitz M. and Yeaple S.R. (2004), ‘Export versus FDI with Heterogeneous Firms’, American Economic Review vol 94(1), 300-316.

OECD (2013), ‘Interconnected Economies: Benefiting from Global Value Chains’, OECD Publishing. doi: 10.1787/9789264189560-en

Veugelers, R., F. Barbiero, M. Blanga-Gubbay, (2013), Meeting the manufacturing firms involved in GVCs, in Veugelers, R. (2013) (Ed.) Manufacturing Europe’s Future, Blueprint no 21, Bruegel, Brussels.