1 Innovation and Firm Performance in a Catching-up Economy

There are a number of studies on the relationship between the innovation and firm performance in the case of highly developed countries, starting with the classic paper by Crépon et al. (1998), however there are only very few studies on the developing countries and similar studies on Central and Eastern European catching-up economies seem to be lacking. This paper studies whether there is significant association between product or process innovation of firms and their productivity in Estonia, a small catching-up economy. We use firm-level data from the Community Innovation Surveys (CIS3 and CIS4) combined with the Estonian Business Register data on the population of all firms and compare the results with similar studies of other European countries. We apply for the analysis a structural model that involves a system of equations on innovation expenditure, innovation outcome and productivity (called in this literature CDM model). Our results show that process innovations have a strong positive effect on productivity, but there is no effect of product innovations