Financial Crises and Innovation

Focus

Growth and productivity are persistently low following financial crises. This paper examines how financial crises affect innovation. Patents are an important measure of the kind of innovative activity that can lead to productivity gains. We study patent data from a broad sample of countries and financial crises and consider impacts up to 10 years after a crisis.

Contribution

This is the first cross-country study on how financial crises affect patenting. Our sample includes crisis episodes of different types across many different countries. This allows us to establish general patterns connecting financial crises and innovative activity. We distinguish between types of crises and recessions to understand these outcomes better.

Findings

Some industries are more reliant on external funding, such as from banks, to finance their activities. We find that these industries decrease their patenting more following a financial crisis than other industries. The effect is persistent, lasting upwards of 10 years, and is specific to banking crises. This indicates that when firms lose access to bank credit, they may be forced to drop new and ongoing R&D projects. This results in fewer patents over the following years. These results provide a link between financial crises and the sustained decline in output and productivity observed after a recession.

Abstract

Financial crises are accompanied by permanent drops in economic growth and output. Technological progress and innovation are important drivers of economic growth. This paper studies how financial crises affect innovative activities. Using cross-country panel data on patenting at the industry-level, we identify a financial channel whereby disruptions in financial markets impact patenting activity. Specifically, we find that patenting decreases more following banking crises for industries that are more dependent on external finance. This financial channel is not at play during currency crises, sovereign debt crises, or recessions more generally, suggesting that disruption in banking activity matters for investment in innovative activities. The effect on patenting is economically large and long-lasting, resulting in less patenting, in terms of both total quantity and quality, for 10 years or longer after a banking crisis. The average patent quality, however, does not appear to decline. We show the results are not likely to be driven by reverse causality or omitted variables. These findings provide a link between banking crises and the observed patterns of lower long-term growth. Liquidity support in the aftermath of banking crises appears to help reduce the effects through the financial channel over the short term.

JEL classification: E44, F30, G15, G21, O31

Keywords: innovation, financial crises, banking crises, patents, growth