Financial Crises Slow Down Innovation Activities in Businesses

How much corporate customers of banks invest in innovations largely depends on the financing opportunities provided to them. Financial distress of banks as a result of macroeconomic shocks, however, has an impact on the innovation performance of their corporate clients. In times of tensions on financial markets, businesses most likely reduce their innovation activities if “their” banks are particularly hard hit by the distortions in the interbank market. These are the findings of a recent study carried out by the Centre for European Economic Research (ZEW) in Mannheim.

The analysis identified the causal impact of the ailing banking sector on innovation activity in businesses during the global financial crisis of 2007/08. When the US investment bank Lehman Brothers filed for bankruptcy in 2008, the financing conditions in the interbank market worsened dramatically. The trading volume between financial institutions decreased, creating a tough lending climate for companies. On the basis of a cross-sectional analysis, ZEW researchers found that corporate clients of banks, which were particularly active in the interbank market, reduced their innovation activity to a far greater extent than other businesses during the financial crisis.

The analysis is based on data from the Mannheim Innovation Panel (MIP), a survey which has been conducted by ZEW on an annual basis since 1993. The MIP comprises data on more than 20,000 businesses, including information on the companies’ respective primary bank. As part of the study, MIP data was matched with information on the refinancing structure of individual banks and on the business activity of their corporate clients.

The refinancing structure of banks must be stable, even in times of crisis

“Firms which have a business relation to a bank with higher interbank market reliance reduce their innovation activities during a financial crisis to a higher degree than other firms,” explains Professor Kornelius Kraft, ZEW Research Associate, professor of economic policy at the Technical University of Dortmund and – together with Marek Giebel – co-author of the study. “From the company’s point of view, crises affect investments in innovations toa greater extent than current innovation expenditures,” says Kraft. The cross-sectional analysis has further shown that less technology-intensive activities, such as a company’s marketing expenses, are less likely to be affected by this phenomenon.

“Our empirical results imply that a company’s external financing constraints have a significant influence on their innovation activities, especially in times of crisis. This in turn can have negative effects on overall economic growth,” concludes Kornelius Kraft. Two main policy recommendations can be derived from these findings: “Firstly, the refinancing structure of banks has to be designed in a way that guarantees unconstrained credit supply to their corporate customers, even in the event of an economic crisis. Secondly, policy-makers should implement subsidy programmes that make it attractive for businesses to invest in R&D also during economic downturns when other sources of financing are scarce,” says Kraft.

For further information please contact

Prof. Dr. Kornelius Kraft, Phone +49(0)621/755-3152, E-mail Kornelius.Kraft@tu-dortmund.de