Labor Force Demographics and Corporate Innovation

Firms rely heavily on the labor markets from which they draw their employees. In our paper, we consider a fundamental aspect of labor markets, namely, their demographics, and study its effect on corporate innovation. The age structure, in particular, of the local labor force matters because young and old workers are heterogeneous inputs into the firm's production function and they have different effects on the firm's innovation output. As is well known, younger people tend to be more risk seeking, to have longer horizons, and to be more creative, and these characteristics, in turn, tend to make them more innovative compared to older people. What is true for individual workers is also true for the local labor force.

Corporate innovation activities benefit from a younger labor force in a number of ways. First, firms can hire from a larger pool of productive inventors. Similarly, firms can hire younger workers who are not inventors themselves but who complement the firm's inventors in producing innovation, eg, technicians, developers, and managers. Furthermore, local knowledge spillovers arising from the interactions of younger workers across firm boundaries can also increase innovation in the local labor market as a whole. Overall, younger labor markets can create a general work environment, for inventors and non-inventors alike, both within and across firms, resulting in more individual, firm, and aggregate innovation. We hypothesize that it is through this labor supply channel that age structure affects corporate innovation.

Testing this hypothesis is challenging because the direction of causality is difficult to establish. Age structure may affect innovation activity, but innovation may also attract migration to and from a given location, so migration can be mechanically related to age structure. Moreover, age structure may be driven by factors that it has in common with innovation but which are unobservable. Since we are interested in the causal effect of local age structure on local innovation, we need to ensure that the latter does not affect the former.

Our novel approach is to use the age structure of the labor force projected based on historical births. We examine commuting zones, which are ideal units of analysis to study local labor markets because they are designed to capture largely self-contained areas in which people live and work. For every year and commuting zone in the United States, we use historical births in the prior 20-64 years, adjusted for survival, to reconstruct the population of 20-64 year olds. We thus capture the labor force in the absence of migration to and from the commuting zone. This native born labor force of a commuting zone is determined by the people born in that commuting zone between three and seven decades earlier, and it is plausibly exogenous to innovation today.

Turning to our regression analysis, we find that younger labor forces produce more innovation, as indicated by higher patents counts and citations. Since we argue that firms in younger labor markets are more innovative as a result of the characteristics of younger people, we also examine whether their innovation activities reflect these characteristics. To this end, we develop novel measures of the creativity, riskiness, longevity, and interactivity of patents based on patent citations. We find that the innovative characteristics of younger people are indeed reflected in the innovation activities of firms in younger labor markets.

We also examine the inventors who work for firms, to distinguish between inventors and other workers in the local labor force. While we do find that younger inventors are more innovative, we continue to find that inventors in younger labor markets produce more innovation. This suggests that the interactions of inventors, whether inside or outside of their firms, with fellow inventors or other workers in the local labor force, generate knowledge spillovers that affect the quantity and quality of their innovation. The general environment thus appears to be important for the production of innovation.

Since innovation should create growth opportunities for firms, we examine the relationship between labor force age structure and firm valuations. We find that firms in younger labor markets have higher market-to-book ratios, reflecting the value created by younger labor forces. Finally, exploiting differences in the location of employees, investors, and customers, we are able to show that our results are consistent with our hypothesized labor supply channel rather than pure financing supply or consumer demand channels. We conclude that the age structure of the labor force has important consequences for inventors, firms, and the local economy.

Our paper is the first in the finance and economics literatures to show that the age structure of the local labor force has a causal effect on local innovation. Additionally, it offers ready policy prescriptions for the demographic challenges confronting the world today. We find that not only do younger labor forces produce more innovation, they also create more wealth. Our findings provide support for at least three types of public policies that can counter the effects of an aging population: improving the education and training of the native born population; encouraging young and skilled immigration; and incentivizing domestic population growth.

Ambrus Kecskés is Associate Professor at York University - Schulich School of Business.  

Phuong-Anh Nguyen is Associate Professor at York University - Schulich School of Business.

This post is based on their recent paper with François Derrien, ‘Labor Force Demographics and Corporate Innovation’.