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Innovation

Corruption and Finance: Are Innovative Firms Victims or Perpetrators?

Asli Demirgüç-Kunt's picture

Designing policies that promote innovation and growth is key to development. In many countries there is also considerable corruption, with government officials seeking bribes and many firms underreporting their revenues to the state to evade taxes. Might there be a set of reforms that allow policymakers to kill two birds with one stone, both reducing corruption and boosting innovation? New research suggests financial sector reform may be able to play this role.

In a recent paper with co-authors Meghana Ayyagari and Vojislav Maksimovic, we look at corruption—defined as both bribery of government officials and tax evasion—and how this is associated with firm innovation and financial development. Using firm-level data for over 25,000 firms in 57 countries, we investigate whether firms are victims, who pay more in bribes than they gain by underreporting revenues to tax authorities, or perpetrators, who gain more by avoiding taxes than they lose in paying bribes.

Of particular interest is the effect of corruption and tax evasion on innovative firms. Specifically, we explore the following questions:

What Will Economic Recovery Look Like in Eastern Europe?

Paulo Correa's picture

Editor's Note: The following post was contributed by Paulo Correa, Lead Economist for Private Sector Development in the Europe and Central Asia Region of the World Bank.

International debate on the financial crisis has shifted attention to the potential drivers of the future economic recovery. The countries of Eastern Europe were hit hard by the global financial crisis, after having long enjoyed abundant international financing and large inflows of foreign direct investment that brought them high rates of growth, mainly through the expansion of domestic consumption. With the slowing of international trade and the indefinite tightening of financial conditions, sustained economic recovery will depend to a greater extent on productivity gains and growth in exports. 

Two important sources of expansion in firms’ productivity are learning and R&D. Economic research tells us that, depending on size and survival rate, younger firms tend to grow faster than older firms. Because the learning process presents diminishing returns, younger firms, which are in the early phases of learning, will learn faster and thus achieve higher productivity gains than older firms. Innovative firms are expected to grow faster too – R&D tends to enhance firm-productivity, while innovation leads to better sales performance and a higher likelihood of exporting.

What Explains Firm Innovation in Developing Countries?

Asli Demirgüç-Kunt's picture

Many economists agree that innovation is essential for economic growth.  But the little we know about firm innovation is based on the study of large, publicly-traded firms in developed countries.  As Moisés Naím, editor-in-chief of Foreign Policy magazine, pointed out at the recent Financial and Private Sector Development Forum, large, publicly-traded firms have served as the basis for a lot of formal economic analysis, but they are much less typical of developing countries.  This is a problem, since we know from existing studies that small and medium size firms play an important role in developing countries.

What might explain the likelihood of these firms to innovate?   Here are some of the key issues that deserve closer scrutiny:

  • Are certain types of firms more innovative than others?
  • What is the role of finance, governance and competition?
  • Is ownership or corporate form important?
  • Does foreign competition or trade openness matter?
  • And what about the education and experience of managers and workers?