Employment Effects of Innovation at the Firm Level

Abstract

This paper analyzes empirically the effects of innovation on employment at the firm level using a uniquely long panel dataset of German manufacturing firms. The overall effect of innovations on employment often remains unclear in theoretical contributions due to reverse effects. We distinguish between product and process innovations and additionally introduce different innovation categories. We find clearly positive effects for product and process innovations on employment growth with the effects for process innovations being slighthly higher. For product innovations that involved patent applications we can identify an additional positive effect on employment.

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Employment Effects of Innovation at the Firm Level



Stefan Lachenmaier
Horst Rottmann



Ifo Working Paper No. 27

April 2006





An electronic version of the paper may be downloaded from the Ifo website www.ifo.de.

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Ifo Working Paper No. 27
Employment Effects of Innovation at the Firm Level
Abstract
This paper analyzes empirically the effects of innovation on employment at the firm level
using a uniquely long panel dataset of German manufacturing firms. The overall effect of
innovations on employment often remains unclear in theoretical contributions due to reverse
effects. We distinguish between product and process innovations and introduce in addition
different innovation categories. We find clearly positive effects for product and process
innovations on employment growth with the effects for process innovations being slightly
higher. The effects are stronger in small firms and differ between firms in former West and
East Germany.

JEL Codes: J23, O30, L60
Keywords: innovation, labour demand, employment, firm size, panel data




Stefan Lachenmaier
Ifo Institute for Economic Research
at the University of Munich
Poschingerstr. 5
81679 Munich, Germany
Phone: (+49) 89-9224 1696
E-mail: lachenmaier@ifo.de



Horst Rottmann
Research Professor at the Ifo Institute for
Economic Research at the University of Munich
and
University of Applied Sciences Amberg-Weiden
Hetzenrichter Weg 15
92637 Weiden, Germany
Phone: (+49) 961-382 179
Fax: (+49) 961-382 110
E-mail: h.rottmann@fh-amberg-weiden.de

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1. Introduction
This paper delivers empirical evidence for the effects of innovations on employment. It
contributes to the existing research by using a uniquely rich dataset of German
manufacturing firms. The dataset combines annually surveys over the last 22 years and
thus delivers a panel dataset, that allows analyses over a long time horizon. The
theoretical literature stresses the importance of the distinction between product and
process innovations. But for both types the overall effects on employment remain
unclear, with the effect depending mainly on the demand elasticity of the affected
products. Thus, pure theoretical analyses are not able to deliver clear predictions for the
effects of innovations on employment, which raises the need for empirical evidence.
With our data set we can analyze the German manufacturing sector for two decades
with the possibility to distinguish between product and process innovations. In addition,
we introduce different categories of innovation representing different importance levels
of the respective innovations. We also address the questions of whether the effects
differ between small and large firms or differ between firms which are located in former
West and East Germany. In this paper we concentrate on longer periods and do not try
to model the year-to-year employment adjustment processes. This becomes especially
difficult for small firms, which are also part of our dataset.1
The paper is structured as follows. Section 2 gives a short overview about the
existing theoretical and empirical literature in this research field. Section 3 presents our
identification strategy. Section 4 describes the data base and presents the descriptive
statistics. The results are presented in section 5; section 6 concludes the paper.
2. The Literature on Innovation and Employment
2.1 Theory
In theoretical contributions on the impact of innovation on employment, the direction
of the effect of technological progress often remains unclear. Researchers have been
analyzing this task for a long time, and their analyses differ mainly in the methodology
and the data available. An historical overview about the evolution of this field of
research is given in Petit (1995).

1 See e. g. Hamermesh / Pfann (1996)

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In the theoretical literature the distinction between product and process innovations
has been proved important (Stoneman 1984, Hamermesh 1993, Katsoulacos 1986).
Whereas for product innovations it is meanwhile generally assumed that they enhance
employment via a higher demand created by the introduction of new products or an
improved quality of existing products, it is especially the effects of process innovations
that leave open questions.
But for both types of innovation there are effects on employment that go in opposite
directions. The introduction of new or improved products creates a new demand for
these products. This increasing demand leads to an increase in employment in the
innovating firm. But the innovation can also lead to a (temporary) monopoly of the firm
or at least to a very high market share of the firm. If the firm takes advantage of this
situation and increases the product price to maximize its profits the employment level
may suffer from this reduction in the amount of output. Also for process innovations the
overall effect is not clear in theory. As a process innovation improves the labour
productivity, the direct effect of a process innovation might reduce the number of
workers since the same output can be achieved by fewer workers. But, if this advantage
of a cheaper production process is passed on to the prices, this might increase the
demand for the product. This increase in demand might then ─ depending on the
demand elasticity ─ lead to an increase in employment.
To sum up the theoretical contributions, a clear statement is not possible on the
direction of the effect of innovations on employment at the firm level. The effects can
differ significantly depending on the size of the contrary direct and indirect effects,
which depend on the prevailing market structure and on the price elasticity of product
demand.
2.2 Empirical evidence
The empirical literature on technological progress and its impact on different
economic measures is extensive. What we will concentrate on in this paper is the
microeconometric analysis of the effects of innovation on employment.2 This strand of
literature started mainly in the 1990s with the increasing availability of micro data on
firms’ innovation behaviour. An excellent overview of microeconometric analyses in

2 Topics not to be covered in this paper include the effects on wages and skill-biased technological
change.