What role does human capital play in innovation?

Innovation – narrowly defined in business as an improved product or services – leads to corporate growth due to new demand or increased market share, productivity growth due to improved business processes and technology, and overall economic diversification. Innovation at the company level matters tremendously for competitiveness and sustainability and a country’s long-term growth prospects.

Training and education play key roles in firm-level innovation. Photo: ADB

It is commonly understood that one of the key ingredients of innovation inputs include training and human capital, defined as the skills, knowledge and experience of a work force. Human capital strengthens the capacity of a firm to absorb and develop new knowledge and as such it is an essential part of both frontier and catch-up innovation.

In fact, even when implementing technologies and products already available elsewhere, firms still need a workforce with the appropriate skills and knowledge. While policies such as research and development tax credits and direct public funding may boost innovation in the short run, increasing the stock of human capital is more effective in the long run.

Given this broad context on the importance of human capital for innovation, we decided to probe deeper using firm level data covering 27 developing countries in Asia, including about 27,000 firms. This was conducted as background work for Asian Development Outlook 2020: What Drives Innovation in Asia? 

Data is usually a key issue when it comes to examining innovation and its determinants, particularly in a developing country context. While firm-level surveys exist for several developing Asian economies with detailed information on innovative activity and human capital, differences in survey instruments, sampling methodology, and population of inference make cross-country analysis extremely challenging.

The World Bank Enterprise Surveys, on the other hand, have somewhat less detailed indicators of innovation and human capital, but cover a substantial number of developing Asian economies.

We use the World Bank Enterprise Surveys to explore the relationship between a firm’s propensity to innovate and its human capital, proxied by employee educational attainment, employee training, and industry-specific experience of the top manager, which is a neglected but important firm attribute when studying innovation. We also explore whether offering training to employees becomes more relevant when firms face constraints to their operations due to inadequately skilled workers.

We found that firms that provide even minimal formal training to employees are 7.5 and 7.7 percentage points more likely to introduce a new product and implement a new process, respectively. This supports the argument that firm-level training can update or upgrade employees’ knowledge, and more importantly, provide employees with specific knowledge not learned from general education.

A “very small” increase in the share of the workforce with high school education is associated with an increase in the likelihood of introducing a new product by 0.042 percentage points, and the top manager’s experience is associated with an increase in this likelihood by 1.5 percentage points.

Meanwhile, our findings also show that medium and large firms are about 4.6 and 7.4 percentage points more likely to report a new product, and 7.1 and 11.8 percentage points more likely to report a new process than small-sized firms, respectively. R&D expenditure is positively associated with innovative outcomes—firms that spend on R&D activities are 34.8 percentage points more likely to report a new product and 38.4 percentage points more likely to report a new process.

Firms that export, meanwhile, are about 3.2 percentage points more likely to report a new product or process innovation than firms selling only to the domestic markets.

We also investigated whether employer-sponsored training is more strongly associated with innovative activity for firms reporting skill constraints. Once again, we find that training is associated with an increase in the likelihood of introducing a new product by 6.6 percentage points for firms that do not face severe or very severe skills constraints, and 12.4 percentage points for skills-constrained firms. Our findings suggest that employer-sponsored training may be a mechanism to compensate for the constraints resulting from an inadequately educated workforce.

In sum, we show that a firm’s human capital—proxied by the percentage of the workforce with high school education, managerial experience, and employer-sponsored training—is positively and significantly associated with the likelihood of engaging in product innovation, and to a lesser extent in process innovation, suggesting that different aspects of human capital matter to different types of innovation.

Authors:

Sameer Khatiwada is Technology and Innovation Specialist, Southeast Asia Department, ADB.

Rosa Mia Arao is Consultant, Economic Research and Regional Cooperation Department, ADB.