Innovation and Firm Productivity in Central America

This study examined the relationship between firm innovation and firm productivity in five Central American countries, namely, Ecuador, El Salvador, Guatemala, Honduras, and Nicaragua, through the estimation technique of propensity score matching (PSM). Firm innovation is defined based on the introduction of a significantly new product or a significant new technology. Following the literature, the study adopted two measurements of productivity: (i) natural logarithm of annual sales divided by the number of permanent employees and (ii) by estimating total factor productivity (TFP). Using the natural logarithm of annual sales divided by the number of permanent employees’ measure of productivity, the study established that firms that did not introduce significantly new products in the last 3 years are 23.3% less productive than firms that introduce significantly new products. Similarly, firms that did not introduce new technology in the past 3 years are 25.2% less productive than firms that introduced significantly improved technology. From the TFP measure of productivity, the study further confirms that firms that introduced significantly new products in the last 3 years are 32.3% more productive. Furthermore, the study identified that firm productivity is positively and significantly affected by the availability of a line of credit to firms through its interaction with firm innovation. Our key policy recommendation is that firm innovation (product or methods) should be the fundamental basis for extending credit or financial support to the firms.