How to Stay in the Market? - Product and Process Innovation as a Response to Increasing Imports and Foreign Direct Investment

The paper analyses the effects of imports and inward foreign direct investment (FDI) on the innovative activity of domestic firms. The effects are assumed to be positive, since imports and FDI increase the competition on domestic markets and domestic firms have to perform more efficiently to maintain their market position. The hypothesis is tested on the basis of a panel data set containing 1270 firms of the German manufacturing industry over the period from 1984 to 1989. For the econometric estimation two different approaches are applied and compared: the pooled probit estimator with time-varying intercepts and Chamberlain’s random effects probit. The latter accounts for unobserved heterogeneity depending on exogenous variables and allows for a flexible covariance structure of the error term. It is found that both import share and FDI-share have positive significant effects on product and process innovation, but they seem to play a more important role as a determinant of product innovation. J.E.L.-classification: 229, 621