At a CEPR lunchtime meeting on 10 December, Christine Greenhalgh presented the results of her recent research on the influences of innovation, industrial relations and pricing on the performance of the UK balance of trade. Dr Greenhalgh is a Fellow of St Peter's College, a Research Associate of the Institute of Economics and Statistics, University of Oxford, and a Research Fellow in the Human Resources programme at the Centre for Economic Policy Research. Her talk was based on CEPR Discussion Paper No. 487, `Innovation and Export Volumes and Prices: A Disaggregated Study', written jointly with Rob Wilson and Paul Taylor, which drew on research funded by the UK Economic and Social Research Council. The ESRC also provided financial support for the meeting as part of its support for the Centre's dissemination programme. The views expressed by Dr Greenhalgh were her own, however, not those of the ESRC nor of CEPR.

Greenhalgh noted first that the improvements in the UK's economic performance in the mid-1980s have recently fizzled out. The economy now faces the twin problems of trade deficits and excessive inflation, which have been all too familiar during the post-war period. Government policy has therefore been forced back into the `stop' mode, from the `go' mode preferred by consumers, employees and entrepreneurs alike. She noted the general agreement among economists, policy-makers and business leaders that a broad base of efficient manufacturing and tradable services industries supplying high-quality outputs is necessary for the achievement of continuing uninterrupted economic growth. Firms must innovate constantly by upgrading their product ranges and improving their production techniques to keep pace with the improving quality of foreign competitors' products without incurring cost inflation. Most of the empirical studies supporting this view have been based on purely cross- sectional data, however, whether by country or by industry, which have been unable to determine any clear pattern of cause and effect over time.

Greenhalgh investigated the relationship between innovation and trade performance for a large number of UK manufacturing and traded services industries using measures of innovation reflecting R&D outputs rather than inputs. These included survey data on `key innovations' the first successful commercial uses of significant new products and numbers of patent registrations. She noted major divergences among industries in the effects of innovation and clear evidence of the importance of non-price factors in maintaining market shares and net trade balances for most sectors. The positive gains from innovation have generally been larger in mature industries than in high-technology sectors. In particular, the motor industry showed no evidence of a trade response to R&D output, presumably on account of its domination by multi-national corporations which can easily concentrate their research activity which generates innovation in one country and their production in another, in accordance with comparative advantage. Net exports influence real output and employment and, together with the terms of trade, determine the balance of trade on the current account. The volume of net exports responds positively to innovation for almost all manufacturing and service activities.

Greenhalgh noted that innovation may also influence the balance of trade through its effects on export prices. Innovations leading to improvements in product quality have been accompanied by price rises in less competitive industries, such as banking, insurance and financial services, which in turn have benefited the balance of trade. Innovations leading to cost reductions have only improved the trade balance for cases satisfying the `Marshall-Lerner' condition, i.e. for goods whose export and import price elasticities sum to more than one. Greenhalgh found substantial variations in the intensities of competition faced by individual industries in world markets. There was little relationship between the rate of innovation and the price elasticity of demand, however, which suggests that rapid technical advance is insufficient to establish monopolistic advantage. Only one-third of the manufacturing industries in the sample satisfied the Marshall-Lerner condition and thus faced price-elastic demand but this minority included several high-technology sectors.

Greenhalgh concluded that product quality and price competitiveness both contribute to the improvement of the balance of trade and that continuous innovation in both products and processes is vital to successful trade performance. The links between R&D inputs and innovation are not straightforward, however, and many industries and service sectors benefit considerably from innovations produced in other sectors. But further investigation of the R&D process is difficult, owing to the shortage of satisfactory data for many of the relevant variables.