Industrial and Corporate Change Advance Access published March 24, 2007

Industrial and Corporate Change, pp. 1 of 24

doi:10.1093/icc/dtm003

Learning, product innovation, and firm

heterogeneity in developing countries,
evidence from Tanzania
Micheline Goedhuys

Using firm data, this study investigates the various sources of firm learning,
investment and linkages, and their importance for product innovation in Tanzania.
The analysis reveals important differences in innovation strategies for foreign and
local firms. Foreign innovative firms have stronger vertical linkages with other
foreign firms and invest more in human and physical capital. Local firms offset
these disadvantages through in-house R&D, connectivity, and collaboration with
other local firms, proving to be more embedded in the local industrial structure.

1. Introduction
In recent years, there has been an increased interest, by both policymakers and
academics, to understand the processes of innovation that underlie corporate success
and international competitiveness of firms and states. This is especially true for
developing countries, as the knowledge intensity of production increased worldwide
and competitiveness of firms active on world markets became increasingly
determined by their ability to innovate (Mytelka and Farinelli, 2003). However,
also in their home markets local firms’ positions in developing countries are more
and more challenged by the competition from cheap imports. Following the
liberalisation of the trade regime of many least developed countries including a
number of African countries, basic goods are now entering least developed country
(LDC) markets, putting local firms under fierce competitive pressure.
At the same time, many LDC governments engaged in a race to attract foreign
direct investment (FDI), to bring new technology and managerial and production
skills to the country, and to increase the capital stock. It was also expected to create
opportunities for local firms to tap from the world knowledge stock and to benefit
from technology transfer from foreign firms. However, evidence of positive spillovers
from foreign to domestic firms in least developed countries is scarce and mixed. Too
wide a technology gap between local and foreign firms seems to hinder transfer of
technology.

ß The Author 2007. Published by Oxford University Press on behalf of Associazione ICC. All rights reserved.
2 of 24 M. Goedhuys

This has led to the recognition of the importance of learning and innovation
within local firms. The literature on firm learning developed over the last 20 years has
identified the learning process as a costly and risky one, as firms have to invest in
R&D, training, and information search, the outcome of which is uncertain. However,
also the broader socio-economic and institutional context in which firms operate, the
innovation system, is found important in driving innovation. Firms undertake
innovation activities in collaboration with other firms and non-firm institutions to
source knowledge from sources external to the firm. For least developed countries,
where financial markets are poorly developed and biased towards larger and foreign
owned firms, the importance of such linkages among local and smaller firms is
potentially very large as they act as non-market mechanisms through which firms
share knowledge and risk.
While linkages are fully recognised as important determinants of knowledge flows
and firm learning, the empirical evidence on learning and collaboration for
innovation is very thin for least developed countries. It is also mostly based on a
small number of firms or on case studies. Additionally, the role that foreign firms
play in stimulating local innovation efforts is scarcely documented. This article
addresses this problem by analysing the learning and collaboration behaviour of a
sample of both local and foreign firms and firms of different size, using a unique data
set from Tanzania. Tanzania has liberalised its economy over the past two decades,
and privatised its strong direct government participation mainly in favour of foreign
investment, making the study of the foreign–domestic dimension highly interesting.
Using firm level data, the study first provides empirical evidence on the various
sources of learning, including internal sources such as R&D, skills and training of the
workforce, investment in new equipment, and telecommunication, as well as external
sources through linkages and collaboration with other firms. The article subsequently
relates learning and collaboration to product innovation to see how these learning
activities are related to successful product innovation.
The data of the World Bank’s ‘‘Investment Climate Survey’’, conducted in
Tanzania in 2003, are used in this study. Though the survey was not designed as an
innovation survey, a large amount of useful information could be extracted, giving
valuable insights on largely unexplored questions. First, by using information from
both foreign and local firms, not only the linkages between foreign and local firms
are documented. Also collaboration among domestic firms on the one hand and
linkages among foreign firms on the other hand are taken into account in the
analysis, revealing important differences in innovation strategies between foreign and
local firms.
Second, the learning mechanisms and linkage intensities are also analysed directly
with respect to product innovation, shedding light on the very processes that may
lead to productivity differences, measured in other studies.
Third, there are, to my knowledge, no studies on LDC’s linking innovation
activities of firms to the eventual introduction of new products. Especially for Africa
 Learning, product innovation, and firm heterogeneity in developing countries 3 of 24

this is missing, possibly due to a scarcity of innovation survey data. The rising
interest for conducting innovation surveys in developing countries, including
Africa,1 shows the perceived importance of product and process innovation for
development and the need to understand the driving forces behind it in a developing
country context. Product innovation is indeed recognised as an important form of
technical change in developing countries (Fransman, 1985; Semboja and Kweka,
2001, for Tanzania), as firms need to put deliberate efforts in the search for new
products suited to their markets.
The structure of the article is as follows: Section 2 discusses a selection of the
literature on innovation and learning for developing countries that is relevant to the
empirical section and specifies the research questions to be analysed. Section 3
highlights some of the main characteristics of the Tanzanian economy relative to
learning and innovation. Section 4 discusses the methodology and data and the
construction of the variables. Section 5 presents the results. Section 6 concludes.

2. Innovation and learning in a developing country context:

findings from the literature
An extensive literature emerged since the foundations of evolutionary theory were
articulated, criticising the prevailing ‘‘neo-classical’’2 theory and its assumptions for
its inability to study industry dynamics (Nelson and Winter, 1982: 4; Rosenberg,
1982; Dosi et al., 1988: 120–121). Also, the empirical studies that were based on
conventional models and focussed on total factor productivity growth with the
‘‘unexplained’’ residual capturing technical change were seriously questioned. The
very process of innovation and technical change underlying the unexplained
productivity growth remained largely unexplored and the models did not provide
any significant guidance for policy making. Therefore, shifting the focus of attention
and starting from the earlier documents on technical change in developing countries
[including, among others, Fransman (1985), Katz (1987), Lall (1992)3], research of

1
The first NEPAD Ministerial Conference on Science and Technology requested the NEPAD
Secretariat to undertake activities that would generate an ‘‘African Innovation Outlook’’ (AIO), that
is, a comprehensive data set that allows profiling the innovation landscape. As a basis for an AIO
two distinct but complementary surveys, one on science and technology and one on innovation,
were designed (UNU/INTECH, 2004).
2
Dosi et al. (1988) outlines what is meant with ‘‘neo-classical theory’’ and criticised especially the
assumptions of rational agents, equilibrium thinking, and the weak incorporation of uncertainty in
the models.
3
Lall developed the concepts of ‘‘technological capabilities’’ to study the dynamics of technological
learning in firms that are operating far from the frontier technology. Other researchers built further
on this concept, resulting in a large body of literature, an overview of which is given in UNCTAD
(1996).
4 of 24 M. Goedhuys

the last 20 years has explored the technological learning processes that drive
innovation in firms.
This research revealed that importing new technologies from abroad is not
sufficient to generate productivity growth as technologies developed elsewhere have
to be adapted to or mastered by LDC firms. This requires technological learning
which is costly and risky. Often it involves a tacit component that needs to be
acquired through experience and use, and through the development of new
technological capabilities. It requires a financial commitment on behalf of the firms
to master technology or build up competences and skills, through R&D, training,
engineering activities, and information search, the outcome of which is
uncertain and bears considerable risk (Fransman, 1985: 575–576; Katz, 1987;
Malerba, 1992).
Another central finding is that innovation activities within firms also depend
heavily on sources external to the firm. Learning and innovation are interactive
and systemic processes rather than a linear process driven by R&D. Firms do not
innovate in isolation but in collaboration and interaction with clients, other firms
and non-firm agents (Edquist, 2004). Lundvall (1988) showed that user–producer
interactions can be important for successful product innovation. The widely used
concept of ‘‘innovation systems’’ is based on the idea that the innovative
performance of firms is not only determined by their own efforts, but is strongly
influenced by the wider institutional and socio-economic framework in which
their activities are embedded (Cassiolato et al., 2003; Edquist, 2004; Fagerberg,
2004).
The interactive nature of learning is also a key element in the more recently
developed literature on clustering, which studies knowledge flows between firms
in geographical or sector agglomerations. Schmitz and Nadvi (1999) introduced
the concept of ‘‘collective efficiency’’ to refer to the competitive advantages of
geographical or sector agglomeration, derived from external economies and joint
action. External economies are the benefits firms enjoy of being merely located
geographically close, including the availability of skilled and specialised labour,
specialised suppliers, superior provision of utilities and infrastructure, and
improved access to markets and information (Mccormick, 1999). Joint action
on the other hand refers to intentional collaboration, linkages, and networking of
firms in the cluster. They can reduce the costs related to information and
communication, the time needed and risks associated with the introduction of
new products. Bell and Albu (1999) developed a conceptual framework to
investigate clusters capacity to generate and diffuse knowledge based on their
openness to external knowledge sources and the intensity of collaboration between
firms. More recent studies go on modelling and analysing the relationship
between clustering and intra-firm learning, and they look at the different role
individual cluster firms play in absorbing extra-cluster knowledge and diffusing
 Learning, product innovation, and firm heterogeneity in developing countries 5 of 24

knowledge within the cluster (e.g. Caniels and Romijn, 2003; Giuliani and Bell,
2005).4
Inter-firm knowledge flows are also studied in the empirical literature that focuses
on knowledge spillovers from foreign owned to domestic firms in host countries.
This is mostly done by analysing productivity differences of firms over time, at
different levels of exposure to foreign investment in the same sector or in supplier or
user sectors. While for developing countries there seems to be no robust empirical
evidence of horizontal spillovers—knowledge spillovers from foreign firms to
competing local firms in the same industry—(Aitkin and Harrison, 1999; Djankov
and Hoekman, 2000; Konings, 2001), evidence of spillovers through backward
linkages—from foreign firms to their local suppliers—is more likely to be observed
and is indeed found for some countries (Blalock, 2001; Schoors and van der Tol,
2002; Javorcik, 2004). The innovation process that leads to this productivity shift and
the importance of local knowledge flows between domestic firms is in these studies
not taken into account.
The costly and interactive nature of technological learning has important
implications for firms in LDCs, where financial markets are typically poorly
developed. Some authors have shown that in LDCs, financial markets are biased
against SMEs and favouring larger and foreign owned firms that enjoy a more
legitimate status in the industry, facilitating their growth and investment
opportunities (e.g. Nugent and Nabli, 1992; Harrison and McMillan, 2002;
Sleuwaegen and Goedhuys, 2002, 2003; Beck et al., 2005). This institutional aspect
of the business environment affects firms’ opportunities for learning and their choice
of innovation strategy. The more financially constrained micro-enterprises and small
and medium sized firms may find themselves in a disadvantages position to engage in
learning efforts that require a strong financial commitment. Linkages can then
become an even more important non-market mechanisms to share information,
knowledge, investment, and risk, and they may offer unique opportunities for local
SMEs to engage in a process of continuous learning and innovation.
This study integrates these findings of the literature into the empirical analysis. It
analyses differences in learning mechanisms and collaboration intensity of firms in
Tanzania, to see subsequently how these translate into successful product innovation.
The focus of the analysis is threefold.

4
Interesting contributions include Caniels and Romijn (2003) who integrate the meso-perspective of
‘‘collective efficiency’’ studies and the micro-economics perspective of technological learning at the
firm level. Also Giuliani and Bell (2005) illustrate the different roles played by firms in a Chilean
wine cluster with respect to the acquisition of knowledge external to the cluster, and their
contribution to the intra-cluster diffusion of knowledge, driving cluster performance. Cassiolato
et al. (2003) present selected case studies from Brazil, discussing the conditions under which
learning and the use of capabilities occur in Brazilian clusters.
6 of 24 M. Goedhuys

First, though it is not possible to trace from the data whether firms belong to a
cluster and how they interact with other cluster firms, it is possible to analyse
whether more intensive collaboration with other firms in the local market is
associated with the introduction of new products. This sheds light on the benefits of
interaction and the possible effects on firm learning in an African country for which
the empirical evidence is really thin.
Second, the impact of linkages with foreign firms and interaction through
subcontracting relationships will be analysed empirically. It is indeed likely that
domestic firms, becoming suppliers of foreign firms, are asked to produce specific
goods. This may lead to activities in the firm that result in new product innovation.
The analysis thus sheds light on the very processes that may lead to productivity
differences, as measured in other studies.
Third, when financial markets are poorly developed, SMEs may rely more heavily
on linkages and less on learning efforts with a strong financial impact. The learning
mechanisms are thus first analysed in relation to size and ownership.

3. Tanzania
Tanzania is a typical least developed country, still heavily based on agriculture, which
accounts for 45% of GDP in 2003 (World Bank, 2005), while industry accounts for
16.4% of GDP, including an important share of mining activities in the North. The
country has been undergoing reforms since 1985 when it started to move away from
a socialist centrally planned economy with large state participation towards a more
liberal market-based economy.
Over the last decade, a large scale privatisation programme was implemented, in
which state participation in industry was reduced, mainly in favour of foreign
participation. Foreign direct investment increased sharply since 1992,5 putting
Tanzania among the major FDI recipient countries of Africa (UNCTAD, 2002). FDI
was mainly concentrated in manufacturing, especially in the food and beverages
industry. The government of Tanzania expected FDI to bring along an injection of
capital and investment, and a transfer of technology, skills, and superior manage-
ment techniques that would benefit the country at large.
There is no doubt that the recent foreign investments have increased the stock of
technology, especially the embodied technology such as machinery and equipment.
Using a case study of two manufacturing firms, Portelli and Narula (2003) find
evidence that technological upgrading has occurred and that its magnitude is
determined by the capabilities within the industrial base in Tanzania. Narrower
technology gaps between firms are more likely to result in backward linkages.
However, as some studies indicate, the scale of technology diffusion from foreign

5
In 1992, FDI was US$ 12 million, but it rose to US$ 193 million in 2002.
 Learning, product innovation, and firm heterogeneity in developing countries 7 of 24

firms to local firms is still limited. Transfer of know-how, design, and R&D
capabilities is not observed (UNCTAD, 2002: 18). According to Szogs (2004) the
linkages between foreign and local private firms remain weak.
At the origin of this lies the low level of human resources and technological
capabilities in Tanzanian firms. The educational and training systems have been
insufficiently oriented towards science and engineering, generating managerial, and
technical skills. In general, the technology policies pursued in Tanzania paid little
attention to the technological needs and problems of local private firms
(UNCTAD, 2002; Utz, 2006). Domestic research capability was built in public
research centres, doing research in priority areas determined by the Tanzania
Commission for Science and Technology. The choice of sectors and research areas
was supply driven, rather than based on an analysis of technological needs and
problems of productive private enterprises. Some state-owned technology support
institutions were established, but today they lack awareness of private sector needs
as well as resources and motivation to carry out their mandate successfully (Lall,
1999; Bongenaar and Szirmai, 2001; Utz, 2006). The linkages between industry and
university and research institutions are weak, as described in Bangens (2004) and
Mwamila and Katalambula (2004).
Under these constraints it can be expected that product innovation in local firms
is mainly taking place as a result of internal learning and inter-firm linkages among
domestic firms, as linkages with research centres and support institutions are weak.
This is also found by Murphy (2002) who points at the importance of networks and
trust for innovation in Mwanza, Tanzania. He found that social networks of business
people support innovation, as trust in these relationships improve the quality of
information exchanges.

4. Data and methodology

4.1 Data
The data used for the empirical analysis were gathered in Tanzania in 2003, in the
framework of the World Bank programme ‘Investment Climate Survey’ (ICS).
Survey data were collected through intensive interviews with owners and managers of
firms. The objective of the ICS was to obtain firm level data that allow analysing the
conditions for investment and enterprise growth in the country. Hence, the many
aspects and constraints of the African business environment that influence the
investment decisions and performance of the firms were tackled, in a number of
sub-questionnaires.
Survey data are interesting for analysing innovative behaviour of firms,
especially in Africa where the traditional measures for innovation such as R&D
intensity and patenting reveal little information. Since innovation surveys were
8 of 24 M. Goedhuys

developed and the OECD’s ‘Oslo Manual’ (OECD, 1992 and 1997) appeared as a
common practice in this field, a new type of innovation analysis emerged,
focussing on firm level innovation activity. The surveys are designed to gather
information on both innovation inputs, including also non-R&D activities with a
strong learning component, and innovation outputs: product and process
innovation. They focus on the innovating firm, the ‘subject’ of innovation who
is the respondent to the surveys. Inherent to this type of data collection and the
resulting indicator construction is a certain degree of subjectivity in the data,
which also holds for the ICS. Despite this criticism, a number of interesting
studies based on innovation survey data appeared, measuring and mapping
innovation, and linking it to firm performance (see e.g. Smith, 2004 for an
overview of studies). Scholars increasingly use the data to increase their
knowledge on the very process of innovation as it takes place within the firm.
The Investment Climate Survey sampled a heterogeneous group of firms for the
interview in Tanzania, including firms of different size, ownership structure and
active in manufacturing and commercial agriculture.6
A total of 276 firms in manufacturing and 98 firms in commercial agriculture
were surveyed. Due to missing responses to some of the variables used, the
actual sample of firms used in the empirical analysis is reduced to 257,
distributed over the different sectors of activity and size classes as shown in
Table 1. The number of firms with foreign participation, 60 in total, is also
presented per sector. They are mostly large (23 firms) and medium sized
(19 firms). Twenty foreign owned firms are owned by a foreign company. The
other foreign owned firms belong to foreign individuals or families, about half of
which belong to the large Asian (Indian) minority active in Tanzanian trade and
industry. Fifteen foreign firms, or about one quarter, were previously state-owned
firms and later on privatised.

4.2 Methodology
The rich data set created by the World Bank ICS includes a large amount of variables
that capture learning, investment, linkages, and innovation. In the literature, there
are a number of empirical studies that proceed to construct composite indexes
measuring technological capabilities or technological intensity (see Wignaraja, 2002
and Rasiah, 2004 for an overview), subsequently linking the index to exports or other
firm performance indicators. I have deliberately not chosen to proceed with the
construction of an index, as I am specifically interested in the different learning

6
The Investment Climate Survey was also conducted for firms active in construction and tourism.
However, the questionnaires used in these sectors did not include the key questions on innovation.
Hence in our study, manufacturing and commercial agriculture are the sectors retained for the
empirical analysis. The latter sector includes the produce of tea, coffee, cocoa, flowers, livestock,
cotton, vegetables, grains, sugar, and other products.
 Learning, product innovation, and firm heterogeneity in developing countries 9 of 24

Table 1 Distribution of the sample of firms, by employment size class, sector and foreign
ownership

Numbers of firms Micro Small Medium Large Foreign Total

1–9 10–29 30–99 100þ sample

Sector of activity
Commercial farming 20 18 9 8 14 55
Manufacturing sub-sectors
Agro-industries 10 17 18 12 15 57
Textiles, garments, leather 5 10 6 5 6 26
Wood working, furniture 13 17 5 4 5 39
Chemicals and paints 3 6 9 4 7 22
Plastics 0 1 2 4 4 7
Paper, printing, publishing 1 11 7 1 2 20
Metal working 6 8 7 1 4 22
Construction materials 1 3 3 2 3 9
Total sample 59 91 66 41 60 257

mechanisms and their importance for firms operating under different financial and
competitive conditions. The differences would be levelled out if an index would be
constructed for the entire sample of firms.
Therefore, the various sources of learning are first discussed separately. This is
done by presenting a number of key variables capturing skills, training, research and
development, connectivity, investment, linkages and collaboration along the firm
size, sector of activity, and ownership dimension. Some statistical tests are done to
investigate the existence of a relationship between the specific learning or linkage
activity and the firm characteristics.
Subsequently, product innovation is modelled following a probit model that
relates the probability of being an innovative firm to the characteristics of the firm
and the underlying learning activities:
INNO
i ¼ a Xi þ bLi þ gIi þ dCi þ ei
INNOi ¼ 1 if INNO
i  0
INNOi ¼ 0 if INNO
i 50

where Xi is a vector with relevant firm characteristics, including firm size and age,
foreign ownership and sector of activity. Li is a set of learning or technological
capability variables, including the skills level of the work force and training, access to
the Internet and R&D. Ii is investment in new machinery and equipment and Ci
represents collaboration or linkages with other firms for product development. The
estimation is also done for local and foreign firms separately, to uncover potential
differences in their innovation strategies.
10 of 24 M. Goedhuys

4.3 Variables
Table 2 presents the construction of the variables for the empirical analysis and some
summary statistics: the mean value and, for continuous variables, also the standard
deviation. In line with the discussion above, the firm’s human capital stock is
measured by the skills level of the labour force (SKILLS), and formal training
(TRAINING). Connectivity is measured by access to the Internet in the firm
(INTERNET), the use of an own website (WEBSITE) and the use of email for
interacting with clients and suppliers (EMAIL). Internal efforts further encompass
R&D (RD) and investment in new machinery and equipment (NEWEQ).
With respect to linkages and collaboration, the firms were also asked to rate the
intensity of collaboration with other local firms for product development, by
indicating on a Likert scale the frequency of interaction, ranging from 1 (always) to
6 (never). From this, the variable was restructured so that higher values indicate
higher intensity of collaboration and rescaled to vary between 0 and 1. Linkages
through subcontracting (SUBCONTR) and backward linkages with foreign firms
(BACKLINK) are also measured (Table 2).
In the probit estimation, the dependent variable is a binary variable for firms that
report to have introduced a major new product line in the period 2000–20027. In this
estimation, the impact of R&D is measured by R&D intensity, to capture the cost of
innovation. Likewise, the value of the investment over 2000–2002 is used instead of
the dummy to come to grips with the costs related to innovation efforts.
Firms are considered as foreign (FOREIGN) if there is foreign participation in the
ownership structure. However, the group of foreign firms includes affiliates of
multinational firms as well as entrepreneurial firms owned and managed by a foreign
individual or family, mostly of Asian or Middle-Eastern origin. To look into
differences of these groups of firms, the probit analysis includes the dummy for firms
owned by a foreign company.
Additionally, to control for sector variations, the probit estimation also includes
a set of sector dummies, the reference sector being firms active in commercial
farming.

4.4 Estimation
Before proceeding to the discussion of the results, a number of comments need to be
made regarding the probit estimation.

7
Product innovation is the introduction of products that are new to the firm. In line with the studies
based on Community Innovation Survey data, the analysis does not focus on innovation through
upgrading existing product lines, nor on process innovation or innovation through organisational
change, due to the generally more stringent definitional concerns about what is meant by ‘new’ or
‘improved’.
 Learning, product innovation, and firm heterogeneity in developing countries 11 of 24

Table 2 Construction of the variables and summary statistics

Variable Definition Mean (Std)

SKILLS (number of professional and skilled production workers)/ 2.18 (3.33)

(number of unskilled and non-production workers)
TRAINING ¼ 1 if the firm has offered formal training to its permanent 0.40
employees, in 2002.
RD ¼ 1 if the firm has invested in design or R&D in 2002. 0.20
WEBSITE ¼ 1 if the firm has a website that it uses for interacting with 0.21
clients and suppliers.
INTERNET ¼ 1 if the firm has internet access. 0.47
EMAIL ¼ 1 if the firm regularly uses email for interacting with clients 0.56
and suppliers.
NEWEQ ¼ 1 if the firm has invested in new machinery and equipment 0.44
over the period 2000–2002
COLLAB Intensity of collaboration with other local firms for product 0.19 (0.29)
development, [0,1]
SUBCONTR ¼ 1 for firms that produce as subcontractor for other firms 0.12
BACKLINK proportion of output that is sold to multinationals located in 0.03 (0.14)
Tanzania
INNO ¼ 1 if the firm has introduced a major new product line in 0.32
2000–2002
FOREIGN ¼ 1 if there is foreign ownership participation 0.23
MNE ¼ 1 if the owner is a foreign company 0.08
LEMPL Total number of employees, in 2002, in logarithmic terms 3.75 (1.49)
RDINTENSITY R&D expenditures/sales, for 2002, expressed in% 0.87 (8.02)
LNEWEQ Value of investment in new machinery and equipment over 5.80 (4.43)
2000–2002, in logarithmic terms

The equation was subject to simultaneity bias, especially with respect to R&D and
training, both of which refer to 2002, and to the investment in new machinery and
equipment, that is measured over 2000–2002, the same period over which product
innovation is measured. Ideally, the use of lagged variables could solve this problem
and facilitate an interpretation on the direction of causality. Unfortunately, these
data are not available, and there is no information at hand to reconstruct them
somehow. Therefore, to correct for the simultaneity bias and given the limited
number of observations in the sample, the endogenous variables were instrumented
and their predicted values were used in the probit model on product innovation
(following Maddala, 1983). The incidence of offering training to the employees
(TRAINING) was estimated in a probit using as instruments the presence of a labour
12 of 24 M. Goedhuys

union in the firm and the education of the general manager. For R&D intensity
(RDPERSAL), the profitability of the firm is used (following Klette and Griliches,
2000: 376), measured by the value of sales minus the purchase of raw materials,
energy cost and labour costs, and over sales. The value of investment in new
machinery and equipment (LNEWEQ) was instrumented by a binary variable for
firms that have an overdraft facility with their banks, thus measuring firms’ access to
flexible forms of liquidity or credit. Firm size, ownership, sector and location
variables were used as additional explanatory variables in all equations, as well as one
binary variable equalling one if the firm reported not to be credit constraint.
It also has to be mentioned that due to high correlation between the connectivity
variables, only INTERNET was included to prevent multicollinearity problems from
obscuring the real impact of the internet.8
Admittedly, the results still need to be interpreted with caution, especially with
respect to the causal relationship between the variables. Nevertheless, it is still
interesting to note the positive correlations between particular innovative activities
and strategies and product innovation and this for different types of firms, as will be
demonstrated in the next sections on the results.

5. Empirical results
5.1 Learning and linkages in Tanzania
The different learning mechanisms and their importance for firms of different size,
sector and ownership structure are shown in Table 3. For binary variables, a chi-
square statistic and its significance are reported. As SKILLS is a continuous variable,
a T-test on differences in mean values was done, for the respective subgroup of firms
versus the rest of the sample. The significance of this test is indicated after the mean
values of the respective subgroup.
Looking first at the size dimension, it is clear that all of the learning variables are
strongly and significantly related to size, with higher skill levels, training, and R&D
activities and higher occurrence of connectivity and investment in larger firms than
in smaller ones, and the relationship is gradual.
In a similar way, foreign firms outperform their local counterparts in every way.
The difference is significant for all the variables, except for the skills level of the
workforce and the incidence of R&D or design activities. This is in line with the
findings discussed by UNCTAD (2002), which indicated that the transfer of know-
how, design, and R&D capabilities is weak in Tanzania. Foreign firms invest more
in new machinery and equipment, they are better connected to the Web, and train

8
Correlation coefficients being 0.80 for internet and email and 0.47 for Internet and website. The use
of internet is indeed systematically in between the use of email, which is most common, and the
ownership of an own website, which is least common, as shown in Table 3.
 Learning, product innovation, and firm heterogeneity in developing countries 13 of 24

Table 3 Sources of internal learning and investment, by employment size class, ownership and
sector of activity

(1) (2) (3) (4) (5) (6) (7)

SKILLS TRAINING RD WEBSITE INTERNET EMAIL NEWEQ

Mean % of % of % of % of % of % of
firms firms firms firms firms firms

Size
1–9 1.68*** 17.0 6.8 6.8 8.5 17.0 28.8
10–29 1.90 28.6 12.1 16.5 41.8 52.8 39.6
30–99 2.30 60.6 24.2 30.3 69.7 77.3 48.5
100þ 3.34* 68.3 48.8 39.0 78.1 87.8 68.3
X2 n.a. 43.179*** 32.158*** 19.486*** 65.661*** 65.980*** 16.611***
Ownership
Local 2.01 34.0 18.8 17.8 40.6 49.2 39.1
Foreign 2.76 61.7 23.3 33.3 68.3 80.0 60.0
X2 n.a. 14.602*** 0.599 6.626** 14.189*** 17.700*** 8.165***
Sector
Agro-industries 2.17 49.1 21.1 24.6 61.4 68.4 47.4
Chemicals & 2.80 58.6 34.5 37.9 58.6 72.4 58.6
plastics
Publishing & 1.77 31.0 6.9 24.1 62.1 62.1 41.4
construction
materials
Metal working 4.21*** 36.4 27.3 13.6 45.5 59.1 50.0
Wood working 1.55** 30.8 15.4 20.5 35.9 38.5 35.9
Textiles 3.05 57.7 23.1 26.9 53.9 69.2 50.0
Commerical 1.31*** 27.3 16.4 9.1 23.6 38.2 34.6
farming
X2 n.a. 15.663** 8.856 11.411* 23.450*** 21.088*** 6.596

SKILLS (column 1) is a continuous variable. Instead of a X2 statistic, a T-test was done, for the
difference in mean value of each size category, ownership and sector, versus the rest of the
sample firms. The significance of this T-statistic is reported.
Note: *significant at the 10% level; **significant at the 5% level; ***significant at the 1% level.

the workforce more intensively. Additional information from the survey indicated
that on average 9% of the workforce is trained in foreign firms, against only 2% in
local firms.
Some sector variations are also observed, with the highest incidence of formal
training, R&D, connectivity and investment being found in the sector of chemicals
14 of 24 M. Goedhuys

and plastics. The metal working and textiles sectors are also doing relatively well, in
contrast to the sector of wood working and commercial farming, which are
performing generally poorly on the learning and investment indicators.
Table 4 gives information on the firms’ linkages to other firms. The first column
presents the reported intensity of collaboration with local firms in the field of
product development. The proportion of firms that is doing subcontracting work is
shown in column 2, and for those firms that are working in subcontracting
relationships, the proportion of their production produced under this subcontract-
ing relationship is also shown in column 3.
When looking at linkages, the picture is less clear than for the internal learning
variables. Local firms report to collaborate more intensely with other local firms than
do foreign firms, but the difference is not significant. Also the size dimension does
not reveal a strong link with collaboration. The same holds for subcontracting
relationships, which prove to be established independently of size, sector or
ownership. Only a small number of large and foreign owned firms are active as
subcontractor, yet this activity accounts for a large share of the firms’ production.
Interestingly, backward linkages established by supplying foreign firms seem stronger
among foreign owned firms, than between foreign and local firms, a finding that will
be explored more when analysing its impact on product innovation. The relation
between size and the proportion of firms that innovate (column 5) follows an
inverted U-shape, and foreign firms also have a slightly higher propensity to
innovate. It is highest in the chemicals and plastics industry, followed by metal
working.
The findings of Tables 3 and 4 jointly indicate that internal learning activities that
require certain financial commitments, involving risk, are indeed found to be related
to size and foreign ownership. In a developing country like Tanzania, smaller firms
that face more severe financial constraints in imperfect markets instead rely on
networking and collaboration with other firms, to acquire information on markets to
improve or upgrade products and production processes.
In the survey, firms were also asked to indicate the three major ways of acquiring
new technology, out of a list of 14 ways, so as to get the managers’ perception on the
relative importance of the various sources for new knowledge. Though this question
addresses the subjective view of the respondents and the question was not directly
focussing on acquisition of knowledge for product innovation, the analysis of the
responses does show interesting additional and corroborating evidence on how small
versus large, domestic versus foreign firms learn.
For all the 14 ways to acquire technology, an average score could be calculated,9
which is presented in Table 5. As could be expected, the investment in newer vintage

9
For each firm, the most important way to acquire technology was subsequently given a weight of
three, the second most important way was given a weight of two, the third a weight of one, the other
options keeping a zero rating.
 Learning, product innovation, and firm heterogeneity in developing countries 15 of 24

Table 4 Collaboration, linkages and product innovation, by employment size class, ownership
and sector of activity

(1) (2) (3) (4) (5)

% of
COLLABa SUBCONTR subcontracted BACKLINKa PRODUCT
productiona INNO

Mean % of Mean Mean % of

firms firms

Size
1–9 0.16 15.3 22.1 0.25*** 13.6
10–29 0.20 9.9 11.8** 6.90*** 30.8
30–99 0.17 18.2 39.8* 2.18 48.5
100þ 0.22 4.9 51.5 2.43 36.6
X2 n.a. 5.118 n.a. n.a. 17.826***
Ownership
Local 0.20 13.2 25.2 2.55 29.4
Foreign 0.15 10.0 38.4 6.40* 41.7
X2 n.a. 0.432 n.a. n.a. 3.144*
Sector
Agro-industries 0.18 12.3 50.4 2.11 24.6
Chemicals & Plastics 0.04*** 10.3 38.3 1.72 55.2
Publishing & 0.19 10.3 9.5 3.97 27.6
construction materials
Metal working 0.24 27.3 15.3 8.45 40.9
Wood working 0.24 12.8 24.2 1.36** 33.3
Textiles 0.09*** 15.4 11.0 7.04 38.5
Commercial farming 0.26** 7.27 33.0 3.27 23.6
X2 n.a. 6.234 n.a. n.a. 11.898*

a
a T-test was done, for the difference in mean value of each size category, ownership and
sector, versus the rest of the sample firms. The significance of this T-statistic is reported.
Note: *significant at the 10% level; **significant at the 5% level; ***significant at the 1% level.

machinery and equipment is by far the most important way to acquire new
technology. This is followed by technology developed in-house and through the
hiring of key personnel, as can be seen from the magnitude of the score presented in
the last column. However, some ways of acquiring technology are positively related
with size, such as, investment in machinery and equipment, the hiring of key
personnel, and technology transferred from the parent company. Inversely related to
firm size are technology developed in-house, trade fairs, technology adapted from the
16 of 24 M. Goedhuys

Table 5 Relative importance of different ways to acquire new technology, by firm size and
ownership

Average score Micro Small Medium Large Local Foreign All firms

New machinery 0.80 1.01 0.97 1.43 0.92 1.33 1.02

Developed in-house 1.22 0.90 0.94 0.64 1.03 0.67 0.94
Hiring key personnel 0.34 0.45 0.90 1.05 0.46 1.21 0.63
Trade fairs 0.44 0.35 0.34 0.33 0.41 0.23 0.37
Consultant 0.34 0.33 0.24 0.52 0.34 0.34 0.34
Adapted from competitors 0.47 0.46 0.13 0.10 0.36 0.20 0.32
Cooperation with suppliers 0.10 0.33 0.45 0.07 0.29 0.20 0.27
Study tours 0.14 0.29 0.13 0.12 0.21 0.11 0.19
Cooperation with clients 0.02 0.27 0.07 0.17 0.15 0.15 0.15
Parent company 0.00 0.09 0.24 0.31 0.10 0.28 0.14
University 0.05 0.17 0.10 0.00 0.11 0.07 0.10
Business association 0.10 0.07 0.04 0.00 0.05 0.10 0.06
Licence from intl. Sources 0.03 0.02 0.06 0.17 0.06 0.05 0.06
Licence from domestic sources 0.03 0.03 0.00 0.07 0.04 0.00 0.03

competitors and through business associations. In other words, smaller firms acquire
technologies in ways that are less resource intensive and more relying on the other
agents in the system. Likewise, it can be seen that domestic firms are more actively
working internally through in-house activities, study tours, and trade fairs, in
cooperation with suppliers, copying competitors, and sourcing from universities
than foreign firms, which implies they are more strongly rooted in the local
productive structure. Foreign firms on the other hand rate investment, the hiring of
key personnel and sourcing from the parent company as major ways of acquiring
technology, revealing a better financial endowment and a smaller involvement in the
local industrial structure.

5.2 Learning, linkages, and product innovation

The impact of these different learning and collaboration mechanisms on product
innovation is shown in Table 6. Not the estimated coefficients of the variables are
shown, but the marginal effects, so that the magnitude of the effects can be seen from
the table. For dummy variables, the reported figure reflects the impact of the discrete
change of the dummy variable from 0 to 1. For continuous variables, the change in
the probability of being a product innovator for an infinitesimal change in the
continuous variable is presented (dF/dX). The significances refer to the significance
of the test of the underlying coefficient being 0.
 Learning, product innovation, and firm heterogeneity in developing countries 17 of 24

Table 6 Results of the probit model on the probability of being a product innovating firm

All firms All firms Local firms Foreign firms

dF/dX SE dF/dX SE dF/dX SE dF/dX SE

LFIRMAGE 0.001 (0.035) 0.053 (0.050) 0.032 (0.052) 0.241 (0.132)*

LEMPL 0.365 (0.107)*** 0.026 (0.043) 0.000 (0.050) 0.220 (0.125)*
LEMPL sq. 0.032 (0.012)** – – –
FOREIGN 0.003 (0.081) 0.019 (0.094) – –
MNE 0.014 (0.128) 0.206 (0.102) – –
SKILLS – 0.021 (0.010)** 0.013 (0.013) 0.122 (0.048)***
TRAINING – 0.158 (0.354) 0.097 (0.380) 0.809 (1.080)
INTERNET – 0.187 (0.073)** 0.237 (0.087)*** 0.147 (0.254)
RDPERSAL – 0.041 (0.018)** 0.046 (0.020)** 0.057 (0.042)
LNEWEQ – 0.033 (0.015)** 0.029 (0.017)* 0.111 (0.045)**
COLLAB – 0.213 (0.101)** 0.282 (0.101)*** 0.471 (0.319)
BACKLINK – 0.305 (0.191) 0.004 (0.270) 1.528 (0.509)***
SUBCONTR – 0.195 (0.095)** 0.150 (0.106) 0.353 (0.224)
Metal 0.208 (0.133) 0.020 (0.149) 0.186 (0.184) 0.482 (0.105)*
Paper 0.019 (0.115) 0.023 (0.119) 0.037 (0.140) 0.356 (0.192)
Textiles 0.118 (0.121) 0.059 (0.163) 0.231 (0.205) 0.394 (0.208)
Wood 0.186 (0.114)* 0.153 (0.127) 0.202 (0.156) 0.288 (0.328)
Chemicals 0.239 (0.125)** 0.025 (0.163) 0.071 (0.208) 0.251 (0.275)
Agro-ind. 0.052 (0.092) 0.113 (0.109) 0.010 (0.146) 0.529 (0.230)
Obs. 257 257 197 60
MC Fadden’s R2 0.110 0.191 0.210 0.356

Note: Marginal effects are reported, standard errors in parentheses; Reference sector is
commercial farming; Paper includes paper, publishing, printing, and construction materials,
Textiles includes textiles, garments, leather products, Wood includes wood working and
furniture, Chemicals includes chemicals, paints and plastics. *** significant at the 1% level;
**significant at the 5% level; *significant at the 10% level.

The most interesting result that can be derived from the basic estimation
without learning variables (column 1) is with respect to firm size. Firm size has a
non-linear effect on the propensity to innovate. This is also found when the
estimation was repeated including size dummy variables. Then, medium sized firms
(30–99 employees) are found the more innovative ones, increasing the probability of
being a product innovator by 39%, followed by large (100þ employees) and small
firms (10–29 employees) with a 26 and 22% increase in the probability of being a
product innovator, respectively. Bearing in mind from the previous section that
investment and learning activities were more pertinent in the largest size class,
18 of 24 M. Goedhuys

medium and small firms seem to have found ways to offset this disadvantage. Micro-
enterprises, scoring low on both learning, and investment and linkage indicators,
are clearly the least innovative firms.
From the probit analysis, foreign firms do not seem to be more innovative than
local firms, a finding that contrasts with the bi-variate results from the previous
section. Also the distinction between foreign firms owned by foreign individuals and
families on the one hand and multinationals on the other hand does not show any
significant result when firm size and age and sector of activity are controlled for. The
sector of chemicals and plastics shows superior performance in product innovation
(þ24% increase in the probability as compared with commercial farms), as expected
from the previous section, followed by metal working (þ21%) and wood working
(þ19%).
The inclusion of the learning and linkages indicators (column 2) provides
additional interesting findings. The size and sector effects turn insignificant, as
learning and linkage effects take over in explaining differences in innovative
propensity. The learning variables all have the expected impact, the underlying
coefficients have the right sign. Apart from backward linkages and training, they are
all significant showing that successful product innovation is related to both internal
efforts and investments as well as knowledge sourced from external sources.
Strikingly, when splitting the sample and doing the estimation for local
(column 3) and foreign firms (column 4) separately, the mechanisms that come to
play a role for product innovation appear to be very different for both groups of
firms. While local product innovators are mainly characterised by them having access
to the Internet, by their superior internal research and development efforts and more
intense collaboration with other local firms, foreign firms’ innovative propensity is
not driven by any of these factors. Rather, foreign firms that introduced new
products are mainly characterised by superior skill levels of their workforce in terms
of more professional and skilled workers, by a larger proportion of their output sold
to other foreign firms active in Tanzania and more investments in machinery and
equipment.
Hence, the idea that being a supplier of foreign companies active in Tanzania can
conduce firms to develop new products in that context seems to hold only for firms
that are also foreign owned. This finding points at stronger linkages among foreign
owned firms, than between foreign and domestic firms. Evidence that the gap
between foreign and local firms in Tanzania is large has already been described in
previous studies, but it is striking that it shows up again in a much larger sample.
It would have been interesting to repeat this estimation for MNEs only instead
of foreign firms only, to see the impact of minority groups and their linkage
behaviour, but the sample size gets too small to get meaningful results.
Domestic firms, on the other hand, seem to be more embedded in the local
structure, with more intensive collaboration being related to product innovation.
This finding illustrates the importance of the interactive nature of the innovation
 Learning, product innovation, and firm heterogeneity in developing countries 19 of 24

process. Indeed, by collaborating, and by performing in-house R&D, they succeed in

performing equally well in terms of introducing new products to the market than
their foreign counterparts. Also for local firms, larger levels of investment in new
machinery and equipment are positively related to innovation, revealing the
innovation process as a costly and risky undertaking. For foreign firms, the impact of
the level of investment is even larger in explaining the probability that the firm is a
product innovator, pointing at the better financial resource endowment that
generally characterises foreign firms as compared to local firms in developing
countries.

6. Summary and conclusion

Recent findings in the literature stress the importance of technological learning for
innovation, through in-house efforts and through collaboration with other actors in
the system. In developing countries, where markets for finance, technology, and
information are highly imperfect and more favourable to larger firms, inter-firm
collaboration is likely be an even more important mechanism for SMEs to overcome
the constraints related to the inputs into the innovation process. The role of FDI
herein is also studied and the existence of spillovers from foreign to local firms
investigated, which is a relevant research question, given the eagerness of LDC
governments to attract FDI. However, mixed results of spillovers and the persistence
of a technology gap between local and foreign firms are found in the literature.
Using a unique data set, this article has analysed the learning processes and
linkage behaviour of small and large, local and foreign firms active in Tanzania, and
has investigated the effect of different learning mechanisms on product innovation.
The evidence supports the idea that collaboration can indeed enable local SMEs in
developing countries to be product innovators, even when they show to invest less in
new machinery and to engage less in training and research, development and design
activities than their larger or foreign counterparts, probably due to more severe
financial constraints. Local firms prove to be more embedded in the domestic
industrial structure as they indeed innovate in collaboration with other local firms
and through internal R&D, and by sourcing information from the Internet.
Supplying foreign firms active in Tanzania does not seem a strong enough linkage to
lead to the introduction of new products, pointing at the limited role of foreign firms
in stimulating product innovation in domestic firms.
Foreign firms are equally product innovators, yet the mechanisms leading to
product innovation are different: they hire better skilled personnel, train them more
intensively, develop products for other foreign firms, and invest heavily in machinery
and equipment.
As the linkages of foreign firms with the local industrial base remain weak, impact
of foreign investment on the level technical competences in Tanzania mainly runs
20 of 24 M. Goedhuys

through its contribution to human capital formation. This finding that is in line with
the evidence presented by Blomström and Kokko (2003). Foreign firms train the
labour force intensively to enable them to operate new vintage machinery and
equipment. Foreign firms may also provide the so-needed job opportunities for
highly skilled Tanzanians. In this way, they can help smoothening the brain drain
problem that marginalises the LDCs that invest in formal education without reaping
the benefits of the investment (Archibugi and Pietrobelli, 2003; Utz, 2006; Wamae,
2006).
However, there is potentially more to gain from foreign investment than the mere
human capital development within foreign production facilities. Public policy should
be oriented at stimulating technological learning in the local industrial base by
fostering inter-firm collaboration and partnerships with foreign firms. This may
require investigating the supply side constraints of domestic firms first and
identifying their needs for technological and managerial skills development and
education. To strengthen networks with support and research institutions, it may be
essential to evaluate the effectiveness of the public research agenda and to put
research priorities in line with private sector needs. Putting in place information
mechanisms to foreign investors on local production technology and designing
incentives for technological partnerships between foreign firms and local organisa-
tions can be expected to considerably benefit the country and reduce the observed
innovation system weaknesses.
Finally, the analysis raises an alternative question that could not be fully explored
with the used data set, namely: who benefits from product innovation in a poor
country? Often foreign firms develop new or improved products for export markets
or a small upper segment of the local market and the evidence presented here seems
to confirm this. Local firms are more likely to be familiar with the needs of the poor
and this puts into perspective the value of product innovation by foreign versus local
firms, giving more weight to the latter for their focus on local needs. However,
a recent and controversial strand in business literature, inspired by Prahalad (2005),
describes the enormous opportunities and successful experiences of MNEs that have
started to serve the mass of poor in the lowest income classes, termed the ‘‘bottom of
the pyramid.’’ Using case studies it is shown that producing and distributing
innovative products and services tailored to the needs and problems of the poor can
be potentially very rewarding, due to the magnitude of the market that can be served.
To be successful MNEs not only have to develop highly innovative low cost products
to satisfy specific needs of the poor, they need to form new alliances with
governments, local firms, cooperatives, and NGOs for their superior insights into
local culture and their knowledge of the market. In that respect, policy makers could
consider articulating local research needs and priorities in certain productive sectors,
establish supportive relations with foreign firms and organise the local community so
that they can participate and benefit from such a process. The value of product
innovation in developing countries and the role of foreign and local firms is still
 Learning, product innovation, and firm heterogeneity in developing countries 21 of 24

insufficiently investigated and understood though, yet pro-poor product innovation

is a challenging and important field and more research is expected in this area.

Acknowledgements
I wish to thank Pierre Mohnen, Norbert Janz, Harry Bowen, Leo Sleuwaegen, Lynn
Mytelka, and the participants of the Globelics Conference 2005, Pretoria, South
Africa, for their comments and suggestions. I am particularly grateful to the two
anonymous referees for their constructive comments, which helped me to improve
the article substantially. I also thank Josaphat Kweka, ESRF, Tanzania, and Vijaya
Ramachandran, Manju Kedia Shah and John Nasir at the World Bank for helping me
accessing the data.

Address for correspondence

Micheline Goedhuys, UNU-MERIT, Keizer Karelplein 19, 6211 TC Maastricht, the
Netherlands and Institute of Development Policy and Management, University of
Antwerp, Venusstraat 35, Belgium. E-mail: micheline.goedhuys@skynet.be

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