Does Economic Insecurity Affect Employee Innovation?

How does employee productivity respond to large shocks to household wealth? Over the past several decades, the annual proportion of households in the U.S. experiencing a severe economic loss has been steadily increasing, peaking with the recent financial crisis. The impact of household wealth shocks on consumption, savings, and retirement decisions has been carefully studied in the literature. However, the effect of such shocks on employee behavior has remained largely unstudied. In this paper, we attempt to fill this gap, investigating whether economic insecurity affects employee productivity through the lens of technological innovation, a critical driver of economic growth.

Economists have long argued that the rate and direction of technological change should be understood as the outcome of firms' profit-driven investments in innovation. Indeed, the literature on the determinants of innovation has focused almost entirely on market-level and firm-level factors such as competition, investment horizon, institutional ownership, and organizational structure. This view, however, abstracts away from the individuals who actually produce innovative output within firms. Taking these individuals into account raises the possibility that the personal financial situations of employees might impact the innovative output they produce for their firms. 

To study how economic insecurity impacts employee innovation, we focus on the 2008 financial crisis, which was a particularly severe and widespread shock that led to increased economic insecurity for many individuals. Specifically, we examine whether employees who experienced major declines in the value of their house during the crisis produced less innovative output for their firm as a result. 

Of course, the location of an employee's house is not randomly assigned. For example, it may be that those who live in harder hit areas tend to work at firms that are themselves more affected by the crisis. In particular, firms in crisis-affected areas may experience a decline in local demand, or a tightening of financial constraints stemming from the decline in the value of their real estate collateral. It is also possible that firms located in crisis-affected areas simply tend to be ones that had worse innovative opportunities during this time period for reasons unrelated to the decline in local house prices. To address these issues, our analysis compares only employees working at the same firm-who are therefore similarly affected by firm-level changes in demand, borrowing capacity, or innovative opportunities-but who are exposed to different house price shocks.

Using this empirical approach, we find that negative shocks to housing wealth during the crisis significantly affect employee innovation. We find that employees who experience a negative housing wealth shock produce fewer patents and patents of lower quality based on citations. Such employees are also less likely to patent in technologies that are new to their firm, and, more generally, their patents are less likely to draw upon information from outside their firm's existing knowledge base. Finally, these employees also produce narrower innovations, combining information from fewer disparate fields. 

These effects are more pronounced among employees who are at a higher risk of facing mortgage default. Specifically, we find that housing wealth shocks particularly affect the productivity of employees with fewer outside labor market opportunities, and of employees who had little equity in their house before the crisis. These findings are most consistent with the hypothesis that negative housing wealth shocks lead to decreased innovative output due to heightened concerns among employees about the possibility of mortgage default.
These results may be of interest to policymakers concerned with macroprudential policy related to the housing market, such as the appropriate level of loan-to-value requirements. They also shed light on the origins of innovation within firms.