Dr Tuan Luong and co-authors have published a recent paper in the Journal of Development Economics looking at whether and how import competition affects firm innovation.
This paper re-examines the effect of import competition on firm innovation in the context of China. Specifically, the research exploits China’s accession to the WTO in November 2001. Once accepted by the WTO, China started to fulfill its tariff reduction obligations in 2002 (e.g., the unweighted average tariff dropped from 15.3% in 2001 to 12.3% in 2004, while the weighted average tariff fell from 9.1% to 6.4% during the same period). However, the tariff reductions varied great across industries. Industries with higher initial tariffs in 2001 experienced greater tariff reductions after the WTO accession. Such disparity in the degree of trade liberalization provides with an opportunity to conduct a difference-in-differences (DD) identification. Specifically, to compare changes of innovation in industries facing large increases in import competition due to the WTO accession with innovation changes in industries facing small increases in import competition during the same period.
The paper finds that import competition reduces firm innovation. Overall, patent filings fell in industries experiencing greater liberalization upon WTO accession relative to those experiencing less liberalization. This negative effect of import competition on innovation is consistent with the so-called Schumpeterian effect, in which import competition reduces post-innovation marginal returns and therefore dampens ex ante innovation incentives.