U.S. Innovation and Chinese Competition for Innovation Production

In this paper, we examine how competitive shocks from China impact U.S. innovation through two distinct margins: the markets for innovation and existing products. 

Increasingly there has been a focus on the impact of China's meteoric rise as an economic power and its impact on the innovation spending by established firms in the United States.  There has been a growing interest in this issue by policy makers, politicians, and the popular press.  Issues at stake include job loss, the incentives to innovate, and intellectual property protections.  Yet the existing literature disagrees even on the most basic question.  Does an increase in foreign competition have a positive or negative impact on the intensity of innovative investment in the U.S? 

We examine the impact of Chinese competition in innovation on U.S. firms' R&D and patents using Chinese internet penetration.  We use Chinese province-level data on internet penetration and geographic industry-specific agglomeration data to generate plausibly exogenous variation in the capacity of Chinese firms to challenge U.S. firm innovation.  First and foremost, intellectual property itself is a form of information, and the internet has proven to be an efficient means for accumulating knowledge, especially when the knowledge to be gathered resides overseas and is online in electronic form.  Indeed a wealth of information on intellectual property, product market strategies, and the performance of U.S. firms is available online through the websites of U.S. regulatory agencies. 

Our main conclusion is that increased intellectual property competition has a strong and robust negative impact on U.S. firm R&D spending, realized patents and subsequent long-run sales growth.  This indicates a crowding-out effect as the foreign rivals capture some of the rents of innovation.  Our results vary when firms have high growth options or highly tangible assets.  The impact of foreign innovation competition on U.S. firm innovation is particularly negative for firms that have higher-valued growth options as measured by their market-to-book ratios.  In contrast, the impact is less severe when U.S. firms have more tangible assets and likely higher adjustment costs.  As predicted by existing theories, our results are consistent with firms with trapped assets attempting to differentiate their existing products and thus investing more in R&D.

We find that Chinese import flows impact U.S. firms' patenting activity, in particular in the years right after China's admission into the WTO in 2001.  However, this impact does not reduce the separate impact of competition in innovation from increased access to information via the internet.  The evidence suggests that, in our sample, which is more recent than previous studies, competition relating to innovation is growing in importance relative to competition from existing products, while competition from existing products through import penetration is highly significant in earlier years.

We find that U.S. firms complain more about high competition from Chinese firms, especially in paragraphs where they discuss innovation, when industry-specific Chinese internet penetration increases. Moreover, we find direct evidence of realized ex post competition as Chinese firms apply for more patents that specifically cite the patents of the U.S. firms that are exposed to the internet penetration. In placebo tests, we find little evidence that the Chinese internet penetration impacts R&D and patenting for firms in other major countries outside of China.

Our findings show that global competition influences innovation through at least two competitive margins, each having different implications for innovation spending in the U.S.  The first is examined by the existing studies: direct import competition in the market for existing products.  These existing studies use tariffs and import data, reinforcing their focus on the margin of existing products.  The second margin, which has not been studied in the U.S.-China innovation literature, is direct competition in the market for innovation and intellectual property itself.  Importantly, shocks to tariffs and imports cannot be used as direct shocks to this margin, as both relate to products that already exist, and thus their impact on intellectual property (IP) competition would be indirect and observed with delay.

Overall, our results help to reconcile disagreement in the literature on whether competition leads to increases or decreases in domestic firm innovation.  Given the importance of these issues in political and regulatory circles, we believe more work examining multiple competitive margins and potential intellectual property theft would be invaluable.