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Effects of Licensing Reform on Firm Innovation

Murat Seker's picture

Many studies since the emergence of endogenous growth theory have identified technological innovation as the main determinant of growth. There are structural factors like human and physical capital that contribute to achieving higher innovation rates. However, improving these factors is not sufficient to succeed in innovation. A country’s regulatory environment and investment climate also play important roles in the success of technology adoption strategies and innovation efforts. In a recent paper on the Effects of Licensing Reform on Firm Innovation, I provide an empirical analysis of how the regulatory environment can be crucial for innovation. The paper focuses on regulation of a particular product market that was reformed in India in the mid 1980s and then again in early the 1990s. Before the reform all firms were required to obtain a license to establish a new factory, significantly expand capacity, start a new product line, or change location. Licensing reform meant freedom from constraints on outputs, inputs, technology usage, and location choice as well as easier entry into delicensed industries. Freedom from these constraints allowed firms to take advantage of economies of scale, more efficient input combinations, and newer technologies.

Being motivated by a structural model, the paper shows that the licensing reform had a significant impact on innovation in the formal manufacturing sector in India. Unlike many existing studies that use patents or total factor productivity to measure innovation, here innovation is measured directly as the change in the product mix of the firm. The data for the analysis is obtained from the Prowess Database, which is constructed by the Centre for Monitoring the Indian Economy (CMIE) in India. It is a firm-level panel dataset between 1989 and 1995 that records annual information on firms’ product mix. Hence innovation measured by the product creation rate can be tracked at the firm level. This unique feature of the data allows me to evaluate the relationship between firms’ adjustment of their product lines and licensing reform.

The empirical analysis shows that removal of license requirements led to rates of innovation that were roughly 5 percentage points higher than prior to the reform. There were several other reforms in India such as liberalizations in trade and foreign direct investment policies. Moreover, Indian states vary in the labor regulations applied by local governments and in access to finance. After isolating the possible impacts on innovation of these additional factors, licensing reform continued to make a significant contribution to firms’ ability to innovate. The paper showed that in order to fully benefit from investments in human capital and physical capital to achieve sustainable growth and increased welfare, a favorable investment climate is required. Absent this, efforts to improve the economy and increase innovation will remain incomplete.


Seker, Murat (2012), “Effects of Licensing Reform on Firm Innovation: Evidence from India,” Working Paper, World Bank, Washington DC.