Who Needs National Champions?

Well, I am being nimble...

Fretting that the current bout of globalisation could erode Europe’s economic pre-eminence, many European politicians seem to have concluded that having a few business titans would constitute a good first line of defence. The question is not anymore of whether such champions are needed, but whether they should be of the national or the European variety. The advocates of this stance appear to act on the intuitive notion that this ought to be good for their respective national economies.

There haven't been many arguments to contradict them with this far, as empirical evidence on the matter is scant and contradictory. But help is on the way. CESifo Network researcher Oliver Falck has released a working paper that sheds light on the issue, based on his research associated with the project “How to Construct Europe” funded by the German Leibniz Association, and CESifo has just held a conference delving into the question of whether we need national or European champions at all.

Using a uniquely rich industry-level dataset for Germany, Mr Falck’s highly readable paper tests whether large business size in an industry fosters growth in terms of total factor productivity. The results appear to show that champion advocates would have to rethink their strategy.

A Bit of History
The first industrial heavyweights appeared in the 20th century, with firms growing large on the back of mass production and a highly vertical form of integration. Economic historians argue that this suited such backward economies as Germany or France during the 19th century —or Japan and Korea in the 20th, for that matter— to rapidly catch up by effecting large investments and engaging in technological imitation.

But the resulting rise in economic wealth put paid to this cosy state of affairs. Customers were now no longer satisfied with the standardised, mass models (Mr Falck cites the example of 70% of shirts in the US at one moment being white and of the same cut) and started to demand more individualised products. It took a mere two decades for individuality to banish uniformity to the sidelines.

This led to a shift in the economies of scale: smaller batch numbers were needed, as standardised mass production could no meet individualised customer requirements. Nowadays, much production is farmed out to suppliers and vertical integration has given way to smaller outfits. In order to compete on the global technology frontier, productivity growth can be realised only by pure innovation, not imitation (China, beware).

Who is More Innovative?
The key question then is, are large firms more or less innovative than their smaller counterparts? As Mr Falck points out, all arguments in favour or against large businesses being more innovative revolve basically around their ability to cope with the uncertainty related to innovation and the ability to appropriate the resulting benefits.

There is something to be said for large businesses being better able to cope with this uncertainty. Deeper pockets make it easier for such companies to finance large-scale, long-term research. Many innovations have come out of such legendary powerhouses as IBM Research or Bell Laboratories, for instance. But then again, much anecdotal evidence points to the contrary: large corporations such as Microsoft nowadays innovate by acquiring tiny highly innovative outfits that happen to develop some technology or product at the very cutting edge. And, as regards the ability to reap the benefits of research: just think of how IBM let go of the personal computer after inventing it because it did not realise at the time what potential it had. Or the fact that some of the innovations that most affect our lives did not exactly come into being in the bowels of a giant conglomerate: think of Google.

This, according to the paper, can be due to the fact that the organisational structure of large businesses is often unsupportive of innovation. An innovator in a large firm usually has only limited property rights to his or her innovation: the new product or process generally belongs to the firm, not the employee who invented it.

Furthermore, there is the difference between process innovation and product innovation. The former tends to benefit large firms more than small ones, while the opposite is true for product innovation. Data show that large firms do perform relatively more process innovation than product innovation.

In short, there is no evidence, from a theoretical perspective, that bigger firms are more innovative, and thus better for a country’s economy, than small ones.

But large firms are keen on locking in the status quo, while obliging politicians (in particular those up for re-election) are keen to avoid the potential fallout in terms of employment or negative impact on national industry should they allow one of these “too-large-to-fail” firms to go bust.

And what does the data say? On the one hand, there is a positive effect of large business on productivity growth in the presence of innovation, in particular process innovation. But this positive effect is overshadowed by a negative impact resulting from large firms’ organisational structures not being supportive of innovation, a fact that is compounded by the role of such firms as successful lobbyists. Those in control of large firms (be they private families, elite cadres or bureaucrats) tend to have good political connections and will do their best to preserve their concentrated control over the nation’s large businesses. This, in turn, leads to market distortions, in particular as regards innovation.

The way out, stresses Mr Falck, is to set up strong institutions that will prevent rent seeking by these industrial titans. In a final word, he pleads for intensifying research and discussion on the matter, and keeping it alive in political debate.

That is what the CESifo Conference labelled“Do We Need National or European Champions?” just did. With keynotes from such heavyweights as Philippe Aghion (Harvard University and latest Distinguished CES Fellow laureate), Paul Seabright (University of Toulouse and editor of Economic Policy), and Martin Hellwig (Max Plack Institute for Research on Collective Goods), it asked whether what's good for General Motors is also good for America, delved into the hidden costs of political sponsorship on industrial firms, examined, from an evolutionary perspective, whether we need a champions-related industrial policy, the relationship between national champions and mergers, foreign takeovers and credit, the competition for corporate headquarters amongst countries, and market integration with regulated firms, all followed by a lively discussion.

Oliver Falck: Heavyweights – The Impact of Large Businesses on Productivity Growth, CESifo Working Paper No.2135

• Other CESifo Working Papers dealing with industrial policy
• CESifo-Leibniz-Ifo Conference "Do We Need National or European Champions?"
• Other CESifo Working Papers by Oliver Falck
• CESifo Working Papers published in the past three months