Energy intensity and efficiency are at the core of the green transition. Using a new firm-level complexity index, this column shows that product upgrading and access to trade with advanced trading partners drive firms to adopt energy-efficient technologies. This is especially the case for small firms, which experience significant energy intensity reductions. Though large firms can use markups to fund upgrades, small firms do not gain market power from increased complexity (instead, they face stronger competition), indicating a need for policy support to adopt cleaner technologies. However, firm debt significantly reduces trade-induced benefits through upgrading.
Energy intensity and efficiency are at the core of the green transition. Although policymakers are already implementing a variety of industrial policies to address the global challenge to reduce energy intensity and improve energy efficiency (Juhász et al. 2023), their effects on international trade have not been clear. In fact, the international trade literature has found ambiguous effects of exports on firm-level energy intensity. Trade can induce exporters to upgrade their technology and thereby reduce their energy intensity (Forslid et al. 2018). However, trade can also induce exporters to adjust their product mix, making them more energy-intensive (Barrows and Ollivier 2018). Nor is the causality easy to be established. Articles examining how exports affect a company’s energy efficiency often mix up two different ideas: the direct impact of exports on energy use and the fact that only certain types of companies are exporting, i.e., the selection effect (Batrakova and Davies 2012, Holladay 2016).
In a recent paper (Lastauskas et al. 2024), we provide causal evidence of trade-induced upgrading on firm-level energy intensity and efficiency. We construct a firm-level complexity index that captures not only the broad range of the goods traded but also the characteristics of the destination markets served (Verhoogen 2023). Besides the product complexity and country complexity index from Harvard Growth Lab, our index also utilises a granular dataset that covers the universe of firms in Lithuania from 2000–2015, merged with the HS6-digit customs data. Our firm-specific external demand shocks are constructed by combining aggregate (Lithuania-wide) product-specific foreign demand growth 1 with firm-specific product sales shares, similar to Mayer et al. (2021).
External demand and firm heterogeneity
While the external demand shocks are exogenous to Lithuanian firms, their impact varies markedly across firms precisely because they have different export baskets, hence the heterogeneous exposures to the exogenous demand shocks. Figure 1 (A) shows an initial uptrend in external demand, reflecting favourable conditions before the financial crisis as firms in transitioning economies like Lithuania expanded in global markets. The downturn during the 2009 financial crisis highlights the vulnerability of these firms to global shocks, followed by a resurgence in 2011, indicating adaptive strategies and regulatory adjustments.
Further analysis by firm size (Figure 1B) shows that large firms exhibited robust growth initially but faced sharper declines during the crisis due to deeper integration in global value chains. In contrast, smaller firms with a more localised focus experienced more stable demand patterns.
Figure 1 Growth of external demand over time: Small versus large firms
Source: Ding et al. (2024)
Note: Panel (A) plots the Davis-Haltiwanger growth rate of firm-level external demand. Panel (B) plots the Davis-Haltiwanger growth rate of firm-level external demand by firm size. Small firms are defined as having less than or equal to 50 employees, whereas large firms have more than 50 employees.
Compared to the recent advancements in economic complexity indices (Hidalgo et al. 2009, Stojkoski et al. 2023), which often overlook firm-level dynamics crucial for economic development, our constructed index addresses this issue by combining product complexity and country-specific economic dynamics, providing an enhanced framework for understanding firm behaviours in the global economy.
Figure 2 illustrates the distributional characteristics of key variables such as energy intensity, firm complexity, and firm debt across different firm sizes. Large firms cluster around lower energy intensity growth rates, indicating better capabilities and investments in energy-efficient technologies. Small firms show a greater variation, highlighting large heterogeneity, limited resources and stronger binding constraints.
Figure 2 Distribution of firm characteristics
Source: Lastauskas et al. (2024)
Note: Panel (A) plots the Davis-Haltiwanger growth rate of the sum of expenditure on fuel, electricity, and energy over the firm’s sales. Panel (B) plots the Davis-Haltiwanger growth rate of firm-level complexity index. Panel (C) plots the Davis-Haltiwanger growth rate of firm-level external demand. Panel (D) plots the Davis-Haltiwanger growth rate of firm-level debt over sales. The K-S p-value indicates the Kolmogorov-Smirnov statistic that tests the statistical distinction between small and large firms.
External demand, firm-level complexity, and energy intensity
Using a shift-share quasi-experimental research design (Borusyak et al. 2022) and a traditional panel instrumental variables (IV) strategy (Barrows and Ollivier 2021), we find that external demand is an important driver in the evolution of firm-level complexity, particularly stemming from intensified trade with more advanced trading partners. Increased external demand leads firms to engage in processes and innovations that complexify their operations. Our findings are robust across various model specifications.
Our analysis also reveals a heterogeneous impact of increased firm complexity on energy intensity by firm size. Small firms show significant reductions in energy intensity with heightened complexity, suggesting efficient adaptations. Large firms, however, show only marginal improvements due to structural and operational differences.
The EU accession in 2004 accelerated firms’ adoption of cleaner production processes, reflecting stringent EU environmental directives and increased access to green technologies. This suggests that policy frameworks promoting integration with more advanced economies can have substantial transformative effects on firm behaviours.
Policy implications
We conduct a few extensions to our baseline model. In particular, we analyse how financial constraints interact with the upgrading process. We find that financial constraints hinder energy efficiency improvements. We also construct firm-level markups and explore their dynamics caused by changes in firm complexity.
For small firms, financial constraints do not directly impact energy intensity but do hinder improvements in energy efficiency during the upgrading process. In addition, upgrading efforts lead to temporary markup reductions, as shown in Figure 3. These findings suggest that small export-oriented firms face tougher competition after upgrading. Policies such as export promotions, particularly those fostering partnerships with advanced economies, and improving access to complex intermediate inputs are therefore critical. Ensuring well-functioning input markets – including capital, labour, and R&D investments – is essential for supporting small firms’ upgrading efforts and preventing costly losses due to fragmentation or trade barriers.
Figure 3 Markup growth by firm size
Source: Lastauskas et al. (2024).
Note: The figure plots cumulative impulse response functions identified by local projections (Jorda 2005) with a 90% confidence interval. The vertical axis depicts the reaction of the Davis-Haltiwanger growth rate of firm-level markup in response to a change in the predicted value of the growth rate of firm-level complexity based on SSIV in the first stage. Small firms are defined as having less than or equal to 50 employees, whereas large firms have more than 50 employees. Firm, year, and year-industry fixed effects are included. Standard errors are clustered at the firm level.
Large companies can raise their prices (markups) after making upgrades, which allows them to use their market power to finance these upgrades (refer to panel B of Figure 3). However, financial constraints typically lead to higher energy intensity for large firms, although this negative effect can be reduced by increasing the complexity of their operations. Remedies such as well-functioning capital markets, access to external finance, a strong regulatory environment, and a competitive banking sector can alleviate these constraints. Additionally, promoting trade in more complex products or with more complex markets can effectively counteract the adverse effects of financial constraints.
To summarise, we call for policies that support small firms in their upgrading efforts by facilitating access to finance and promoting export opportunities for all firms, particularly through partnerships with advanced economies, while ensuring that input markets function effectively. Additionally, mitigating financial constraints is crucial to enhance the energy efficiency gains from upgrading. Lastly, promoting free trade and maintaining a competitive environment are vital for energy efficiency improvements in this increasingly fragmented world.
Source : VOXeu
