Firm-embedded productivity and cross-country income differences

What is this research about and why did you do it?

Productivity is a crucial determinant of global income inequality, explaining about half of the variation in income per capita between countries. Our research introduces a novel framework to measure disparities arising from firm-embedded factors like blueprints, management practices, patents, and intangible capital, disentangle them from factors available to all firms in the economy, such as, natural amenities, institutions, infrastructure, and workers’ quality. Understanding these differences is vital for effective policy-making. Bridging the gap in firm-embedded productivity will prompt adoption of various policies, from research and development tax incentives to startup incubator programs, fostering productivity and narrowing income disparities.

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How did you answer this question?

We analyse micro-level data on multinational enterprises, (MNEs), worldwide to measure the contribution of firm-embedded productivity on cross-country income disparities. Despite MNEs being able to transfer productivity globally, they encounter diverse competitors in each country of operation. Differences in market shares of the same MNE across nations spotlight differences in aggregate firm-embedded productivity. Our results show that MNEs hold market shares roughly four times larger in developing countries than in high-income ones, indicating a scarcity of firm-embedded productivity and diminished competition in the former. Remaining disparities in income per capita are attributed to country-embedded factors.

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What did you find?

We show that there is a strong positive correlation between firm-embedded productivity and output per-worker and that differences in firm-embedded productivity account for about one-third of the cross-country variance in output per-worker. The relative importance of the differences in firm-embedded productivity varies considerably across countries. For example, firm-embedded productivity in Italy is 0.28 log-points higher than in Greece, accounting for three quarters of the observed differences in output per-worker between these two countries. In contrast, firm-embedded productivity is similar for Greece and Bulgaria, though output per-worker in Greece is 0.5 log points higher due to the difference in country-embedded factors between these two countries.

Developing accounting: firm-embedded productivity vs country-embedded factors

Note: Each circle (square) represents a country’s firm-embedded productivity (country-embedded factors) relative to France. The figure plots the decomposition in Equation (15), where Δy_n is plotted in the x-axis and Δz_nand Δɸ_n  are plotted in the y-axis. The legend reports the slopes of a bivariate OLS regression of Δɸ_n (Δz_n) on Δy_n.

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What implications does this have for the study (research and teaching) of wealth concentration or economic inequality?

These results underscore a key policy implication: reducing the gap in firm-embedded productivity between countries can markedly diminish cross-country income disparities. Understanding both firm-embedded and country-embedded factors is crucial for tackling global income inequalities. Policymakers can leverage this insight to craft strategies promoting firm-level productivity, fostering economic advancement and equitable development. Additionally, this research offers valuable educational content for courses in development economics, macroeconomics, and international economics, enriching students' understanding of productivity and economic inequality.

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What are the next steps in your agenda?

Expanding our analysis to more developing countries is important. Our new procedure can be easily applied to more countries as new affiliate-parent matched data become available. Also, linking this data to firm-level measures of physical productivity would allow our procedure to be applied under more general assumptions. Finally, we aim to explore the impact of firm-embedded factors on cross-country economic growth differentials.

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Citation

Alviarez, V., Cravino, J., & Ramondo, N.(2023). Firm-Embedded Productivity and Cross-Country Income Differences. Journal of Political Economy (Vol. 131, Issue 9, pp. 2289–2327). University of Chicago Press.