Financial crises and innovation

Focus

Growth and productivity are consistently weak following financial crises. This article examines how financial crises affect innovation. Patents are an important measure of the type of innovative activity that can lead to productivity gains. We study patent data from a large sample of countries and financial crises and examine the impacts up to 10 years after a crisis.

Contribution

This is the first international study on the impact of financial crises on patents. Our sample includes crisis episodes of different types in many different countries. This allows us to establish general patterns linking financial crises and innovative activity. We distinguish the types of crises and recessions to better understand these results.

Results

Some industries are more dependent on external financing, such as from banks, to fund their operations. We find that these industries decline their patents more after a financial crisis than other industries. The effect is persistent, lasting more than 10 years, and is specific to banking crises. This indicates that when companies lose access to bank credit, they may be forced to abandon new and ongoing R&D projects. This results in fewer patents in subsequent years. These results establish a link between financial crises and the sustained decline in output and productivity observed after a recession.


Summary

Financial crises are accompanied by permanent declines in economic growth and output. Technological progress and innovation are important drivers of economic growth. This article studies how financial crises affect innovative activities. Using cross-country panel data on industry-level patents, we identify a financial channel through which financial market disruptions impact patenting activity. Specifically, we find that patents decline more following banking crises for industries that are more dependent on external funding. This financial channel is not in play during currency crises, sovereign debt crises or recessions more generally, suggesting that disruption of banking activity is important for investment in innovative activities. The effect on patents is economically significant and long-lasting, resulting in fewer patents, in terms of total quantity and quality, for 10 years or more after a banking crisis. Average patent quality, however, does not appear to be declining. We show that the results are not likely to be driven by reverse causation or omitted variables. These results link banking crises to observed patterns of lower long-term growth. Liquidity support in the aftermath of banking crises seems to help reduce the effects through the short-term financial channel.

JEL Rating: E44, F30, G15, G21, O31

Keywords: innovation, financial crises, banking crises, patents, growth