The Great Recession of 2008, sparked by a massive housing bubble that gained steam in the early 2000s, caused a systemic banking crisis throughout much of the industrialized world starting in 2007, leading to a global liquidity squeeze and severe restrictions on credit. And while the Recession may have largely receded in our rearview mirror, the effects of the crisis have been felt for years, including on firms’ ability to innovate.
SASN economists Vlad Manole and Mariana Spatareanu recently published a paper looking at the effects of the banking crisis on innovation in the United Kingdom, where the crisis has been lingering longer, and more severely, than in the U.S.
Manole and Spatareanu have worked together at RU-N since 2011. Manole is Chair of the Economics department with a research focus on international economics, international migration and industrial organization. Spatareanu is an Associate Professor of economics and global affairs. She is a core faculty member in the Division of Global Affairs, with a focus on technological spillovers from foreign direct investment, along with factors that affect its flows, including labor market regulations, environmental standards and financial markets.
We sat down with them to discuss their latest journal article and research.
When did you each arrive at RU-N, and how did you first meet?
I came to Rutgers-Newark in 2005, and Vlad joined in 2011. Vlad and I were graduate students when we met, at the CERGE graduate program in Prague. We then continued our Ph.D. studies at Washington University in St. Louis.
You co-authored this paper along with a British colleague. Have you worked on other projects and/or published together in the past?
Yes, the new paper on bank shocks and innovation is part of a larger research agenda on the effect of the 2008 bank crisis on the real economy, co-authored with Prof. Kabiri from the University of Buckingham/FMG–London School of Economics. A previous paper focuses on U.K. exports. The link between finance and the real economy was an important question for the U.K. as the government’s policy was, and is still, focused on trying to improve U.K. exports after the Great Recession. We showed that there were significant negative effects stemming from a lack of bank credit to exporting firms due to bank distress. We used a market-based measure of bank distress, the credit default risk (CDS) spreads, which best capture bank default risk, especially during crises. We were among the first to examine how banks’ CDS spreads affect firms’ export performance during the recent crisis. That paper set the stage for further research.
So, in introducing this paper, you say there’s a growing literature linking bank health to firm performance, but few studies on the effect of bank distress on firms’ innovation. Why shift the focus to innovation, and how is that vital to the health of the economy?
Innovation is a hot topic in economics and finance at the moment. This is partly due to the technological changes we are going through, and the major growth of new technology firms related to this innovation wave. The other reason is the importance of innovation to economic growth. Modern theories of economic growth and wide-ranging empirical evidence suggest innovation as being key for economic growth. Productivity growth is vital for economic development, and innovation and productivity growth are closely intertwined. We aimed to add another piece of the puzzle by understanding what makes innovation slow down and whether finance plays a role. We were motivated by a concern that lack of access to credit could hinder innovation and by extension longer-term economic growth. This was an under-researched area, and we felt it was ripe for investigation.
Can you briefly explain the relationship between banks and firm innovation, and the various ways innovation is affected by bank distress?
The model we derive essentially says that firms need to access finance to grow, and in the U.K. we already know that firms are very reliant on their banks. In the U.S. the picture is different, as much more external
We look at how firms’ innovation was affected from several angles, including patents as an indicator of innovation.
finance can come from bond or equity markets: When a firm needs to invest in innovation to improve its productivity or develop new products, it can finance from its profits or reserves of cash or go outside for funds. During a bank crisis, firms suffer from a withdrawal of credit when banks make themselves safer by lending less relative to their own capital, and firms with less credit are less likely to innovate as they address more immediate needs such as working capital to keep their business going. We look at how firms’ innovation was affected from several angles, including patents as an indicator of innovation: When firms come up with a new valuable idea and take time and capital to produce it, then they apply for a patent to protect it. We looked at patent numbers and quality, and one patent’s effect on future patents and patent values, to grasp of how innovation was affected.
Why focus on U.K. banks and firms? Is it because the effects of the Great Recession have lingered longer there than in the U.S.?
Yes, the U.K. has suffered in terms of both productivity and economic growth since 2008, and the effects have had major repercussions. The country’s productivity level now is essentially the same as it was in 2008, whereas it typically registered 3% growth per annum for the 20 years before 2008. The Bank of England recently forecast U.K. medium-term growth at 1-2%, similar to the average over the last 10 years and well below where the U.K. expected to be.
What are some of the key takeaways from your research?
For the U.K. we discovered things that were both interesting and unexpected. We found that large innovating firms continued to innovate after 2008 even when their bank was in trouble because they could access finance in traded credit markets or the stock market. But it was very different for small and medium enterprises (SMEs), which were stunned by the lack of credit and reduced innovation dramatically. When these firms were affected, all areas of innovation suffered: Patent numbers and quality, along with patent importance and value, were all reduced. And the effects were large: A typical SME suffered a 30% reduction in patent quality. But SMEs whose banks specialize in lending to innovators—who we assume are better able to value technology patents—were less affected. In other words, if the bank understood the value of the patents well, credit was maintained. SMEs produce a large share of the U.K.’s innovation, and so these effects are quite important.
Thank you for sitting down with us.