Innovation and Firm Performance in the Services Sector in Estonia

Abstract

The empirical literature on innovation has devoted too little attention to the differences in relationship between innovation and productivity in various subbranches of the services sector. In this paper, we investigate how the innovation–productivity relationship varies across subbranches of the services sector. For our analysis, we employ the CDM structural model of innovation process, which consists of equations for innovation expenditures, innovation output, and productivity. We use panel data from three the community innovation surveys of Estonia. Our results show that product and process innovation are associated with higher total factor productivity (TFP) of firms in the services sector. Somewhat surprisingly, the effect of innovation on productivity is stronger in the less knowledge-intensive services sectors, despite the lower frequency of innovative activities over there. We also confirm that external knowledge linkages matter a lot in the innovation process of firms in different branches of the services sector.