7. Conclusion There is very little micro based literature on the relationship between innovation and labor productivity in developing countries. To this end, this paper contributes by presenting an in depth analysis of the determinants of product innovation and its impact on labor productivity in the context of a developing economy. The paper employs a multi-stage model linking the decision of firm to innovate, its innovation investment, product innovation, and labor productivity using firm level data from the highly export oriented textile and wearing apparel sectors of Pakistan. The findings reveal some interesting insights into innovation behavior at the firm level that have the potential to serve as inputs to national policy making. First, product innovation leads to increased labor productivity as well as higher labor productivity growth. The elasticity of labor productivity with respect to innovative sales per worker is larger than the estimates of elasticities reported from the advanced economies.
Second, there are interesting regularities in the innovation behavior of firms. The results show that vertical knowledge flows are very important determinants of a firm's decision to engage in innovation. In particular, firms considering foreign clients and foreign suppliers as important sources of information and cooperation have a higher probability to innovate. In line with the Schumpeterian hypothesis, larger firms are more likely to engage in innovation, however, they do not have higher investment in innovation. The impact of competition depends on the location of the competitors: foreign competition negatively affects a firm’s decision to innovate, whereas, local competition positively affects a firm's level of innovation investment. The results point to learning by exporting: firms exporting to Europe and the US are more likely to engage in innovation, and the investment in innovation increases with exports intensity. There is also evidence in support of the crowding out effect of national subsidies: firms receiving national subsides invest less in innovation. Finally, higher investment in innovation, and higher labor productivity lead to higher innovative sales per worker, and there is also evidence of complementarity between product innovations and organizational innovations.
