Productivity has long been recognized as a key determinant of global income disparities between countries. Recent studies suggest that around half of the differences in income per capita can be attributed to productivity variations. However, the question arises: what factors contribute to aggregate productivity? One prevailing view suggests that aggregate productivity is influenced by firm-embedded factors, encompassing the knowledge and expertise ingrained in individual firms through brands, patents, management practices, business models, and other intangible capital. This perspective has led to the implementation of diverse policies worldwide, ranging from tax incentives for research and development to startup incubator programs, aimed at fostering firm-embedded productivity.
Country-embedded factors are another critical component influencing aggregate productivity. These factors include institutions, natural amenities, infrastructure, and workforce quality. Importantly, these elements are available to all firms operating within a country but cannot be transferred across borders. Recognizing the relative significance of these two components is vital for policymakers seeking to design effective strategies to promote economic growth and reduce income disparities among nations.
A policymaker might ask: What would happen to Colombia’s output per worker if all German firms, along with their knowledge, patents, and expertise, were somehow moved to Colombia? Would Colombia achieve the same level of output per worker as Germany, or would it still be significantly lower due to factors like poorer infrastructure, less effective institutions, and relatively less skilled workers?
Distinguishing between the contributions of firm-embedded and country-embedded factors is key. But it is also challenging, as various combinations of these factors can yield a similar output per worker.
Determining Firm-Embedded Productivity
An innovative approach to address this challenge involves comparing the operations of multinational enterprises (MNEs) in different countries. On average, MNEs tend to have a fourfold larger market share in developing nations than in high-income countries. Leveraging this observation, my co-authors and I conducted a recent study introducing a novel method to measure firm-embedded productivity and its contribution to income variation. Our main idea is that MNEs can transfer their productivity globally but must utilize the factors available in the countries where they operate. Since MNE’s franchises could be expected to use similar business models in different countries, differences in their market share between countries would give us an indication of the differences in the productivity of domestic firms in those countries. The remaining differences in income per capita can then be attributed to variations in country-embedded factors.
Our findings reveal that firm-embedded productivity accounts for approximately one-third of the variation in output per worker and significantly impacts income growth, helping to explain why some nations are richer than others. They also indicate that policies aimed at bridging international productivity gaps among firms could mitigate global inequality.
However, there is considerable divergence among countries. For instance, Denmark and Spain exhibit similar output per worker. But while Denmark benefits from stronger country-embedded factors, Spain’s domestic companies are more efficient. Likewise, Italy and Lithuania possess comparable country-embedded factors, but the substantial difference in output per worker between them stems from the lower productivity embedded in Lithuania’s firms. Mexico and Spain have similar levels of firm-embedded productivity, but the significant disparities in country-wide factors explain Spain’s considerable advantage in output per worker.
These variations are also evident across sectors. Japan, Korea, and Germany demonstrate relatively high firm productivity levels in manufacturing, while their firm-embedded productivity in services aligns with that of other developed countries.
These results underscore a clear policy implication: government interventions that help to narrow the gap in firm-embedded productivity across countries can substantially reduce cross-country income disparities. Moreover, improved firm productivity can help countries reshape their sectoral composition and gain advantages in their key operating sectors. Importantly, these conclusions remain valid regardless of the size of a nation’s market.
Understanding the interplay between firm-embedded and country-embedded factors is essential for tackling global income disparities. Policymakers can harness this knowledge to design effective measures that promote firm-level productivity and foster economic growth, ultimately paving the way for more equitable development among nations.