The relationship between firm investments and technological innovation and political action.

• Author: Taylor, Davis F.

1. Introduction

   Economic theory recognizes the importance of investments in both technological innovation and political activity in firm behavior, and extensive research exists which examines independently these expenditures. However, surprisingly little attention is devoted to analyzing technological innovation and political action expenditures jointly. Technological innovation and political action are two of the options firms face regarding how to achieve lower costs or market power; the characteristics of these choices not only affect the degree to which each is used, but also have widely divergent normative and policy implications for society. Furthermore, many forms of technological innovation require regulatory approval, so that firms may use the two forms of investment in conjunction with each other in addition to treating them as separate investment alternatives.

   This paper investigates the relationships between firm investments in technological innovation and political activity. Both forms of investment seek to lower costs and/or create market advantage, but economists have long recognized the social importance of technological innovation to economic growth, while treating most firm political activity as inefficient. Growing social concerns surrounding declining innovation, productivity, and growth and increasing firm political activity suggest that these are timely dimensions to explore jointly.

   In the next section I discuss the relationship between firm investments in technological innovation and political action. This discussion motivates the subsequent empirical modelling presented in section III. Because of the possibility of simultaneity between firm spending in research and development (R&D) and Political Action Committee (PAC) spending, and heavy censoring of PAC data, estimation is in the context of a simultaneous censored ("Tobit") model suggested by Smith and Blundell [29]. Data for the study, and expected relationships between R&D, PAC, and control variables, are discussed in section IV. Estimation results are presented in section V. The endogeneity of firm R&D expenditures as a determinant of firm PAC expenditures is not rejected, and there is significant evidence that the two forms of investment are complements; these results hold true to various degrees over industries and industry groups. Section VI offers conclusions and suggestions for further research.

   II Background

   Consider the firm's choices concerning discretionary investments in technical innovation and political activity. The two forms of investment may be substitutes, complements, or have no significant relationship. In this context, investments are defined as substitutes if a marginal change in the use of one corresponds with a change in the opposite direction of the other, and are defined as complements if a marginal change in the use of one corresponds with a change in the same direction in the other.

   The relationship between the two forms of investment generally depends on the relationship between marginal returns to each form of investment, in the same vein as the relationship between labor and capital in a standard profit maximization situation. If there is an increase in the relative return to technological innovation, intuition suggests that firms are likely to invest more in R&D. What is less immediately apparent is that such an exogenous change in the technological environment may alter the relative return, and hence optimal investment levels, in the political environment. A firm may increase its investment in political action in response to increased profitability in that environment and concurrently lower its investment in technological innovation because the expected change in the political environment makes investing in the technological environment less attractive or less necessary. Likewise, increased or decreased profitability in technological innovation could lead to the attractiveness of investment in political action to move in the opposite direction.

   Numerous economic theories suggest that returns to technological innovation are not static over time, so that alternative investments such as political activity may be attractive substitutes [3; 6; 10; 11; 15; 17; 22; 27; 28]. For example, in the context of Schumpetarian "waves" of technological innovation, if a firm finds itself moving into an innovation "trough," marginal returns to political action may become greater, so that firm managers turn to political action as a means of achieving advantage.

   Alternatively, technological innovation and political action could be complements, at least for some firms or industries. In particular, the political/regulatory environment may lag behind technical innovation, so that firms or industries that invest heavily in technological innovation may find it necessary or beneficial to make political investments to permit the introduction of new technology. In such a situation, firms' political contributions may simply "buy access" to politicians, and/or they may contain information themselves.(1) Once new technology is introduced, political action may be necessary for the firm to prevent other firms from appropriating part or all of the advantage the technological innovation creates, thus raising the marginal return to political action. A third explanation for complementarities is that a firm may seek to increase its sales (via political activity) to further exploit a technological gain that, say, increases per unit profits or depends on economies of scale.

   Recognizing that changes in technological possibilities (and hence profitability) can alter political activity is crucial. Alterations in regulation may be a necessary condition for a firm to realize profits from technological innovation. Any event that impacts profitability in one environment can also impact the other; complete analysis of policy that affects one environment includes analysis in terms of the policy's effects on the other environment. In particular, if firm political activity is a necessary component of technological innovation, then policy designed to increase R&D investment may also have the effect on encouraging increases in PAC expenditures, an activity many citizens think should be limited. Conversely, limits on firm political investment may have a chilling effect on firm R&D expenditures.

   Numerous researchers in several disciplines have examined firm PAC expenditures.(2) Zardkoohi, Munger, and Grier, Munger and Roberts (hereafter referred to as GMR) offer recent economics-oriented studies that investigate the determinants of firm PAC contributions [31; 23; 13; 14]. Regardless of disciplinary origin, most studies focus on or pay considerable attention to a firm's and/or industry's ability to overcome collective action problems, if even to refute the importance of such problems.(3) None of these studies have considered the influence of finn technological innovation on finn political innovation or included R&D expenditures as an explanatory variable in their empirical analysis.

   The few studies that consider technological innovation and political action jointly are in the context of environmental regulation. Research by Downing and by Abbott and Brady offer models in this context, and suggest the possibility of complementarity between firm technological innovation and political action [8; 1; 2]. In most contexts, the firm has a natural incentive to adopt new technology. However, firms subject to environmental regulation may be restricted by the relevant regulatory agency as to the technology it can use to meet pollution emission goals. If cost-reducing technology is available, the firm must lobby the regulatory agency to permit use of the new technology. Presumably there will be economic actors with interests in maintaining use of the current technology, so the firm's lobbying is met with resistance by those actors.

3. Empirical Modelling

   Taylor [30] provides a firm-level theoretical model that suggests that firms determine optimal technological innovation and political action investment levels jointly, even when one form of investment does not affect the probability of outcomes in the other environment, and establishes conditions under which the investments will be substitutes or complements. The theoretical demonstration of the joint determination of technological innovation and political action investment levels is empirically testable. It is also possible to investigate the nature of the relationship between the two forms of investment to see whether they behave predominantly as complements, substitutes, or exhibit no significant relationship across firms.

   Empirical modelling is complicated by significant censoring of the PAC contributions variable. Ignoring this feature of the data produces inconsistent parameter estimates, including those parameters used in testing for endogeneity. Because of this, the primary empirical model used below is of the form suggested by Smith and Blundell [29].(4) The authors develop both a test for endogeneity and an efficient method of estimation in the context of simultaneity and censoring. I also employ a secondary empirical model, of the form suggested by Nelson and Olson, that involves less efficient estimation than that used by Smith and Blundell, but readily permits the use of dummy variables to identify industry and group specific relationships between endogenous variables [24; 29].

   Smith and Blundell formulate a two-equation simultaneous system in which the dependent variable in the first equation is censored [29]. The first equation is structural, while the second is in reduced form. The simultaneous system for firm i(i = 1, ... H) is given as

   [Mathematical Expression Omitted] (1)

   [y.sub.2i] = [x[prime].sub.i][[Pi].sub.2] + [v.sub.2i]. (2)

   The endogenous variable...