The impact of Chinese imports on innovation, it, and productivity

Writing in the August 2011 issue of The NBER Digest Laurent Belsie notes:

In Trade-Induced Technical Change? The Impact of Chinese Imports on Innovation, IT, and Productivity (NBER Working Paper No. 16717), authors Nicholas Bloom, Mirko Draca, and John Van Reenen examine more than a half million firms in 12 European countries between 1996 and 2007. They find that every 10 percentage point rise in Chinese imports in a firm's industry was associated with an increase of: 3.2 percent in patents, 3.6 percent in IT spending, 12 percent in R and D spending, and 2.6 percent in total factor productivity (TFP). The authors observe that more innovative firms tended to grow while the less innovative ones tended to shrink or disappear altogether. In fact, they conclude, a surge in Chinese imports appears to have been responsible for about 15 percent of the technological upgrades at European firms between 2000 and 2007. At the same time , that surge led to decreases in employment, profits, prices, and skill share in the affected industries. Imports from other low-wage nations had a similar impact, but imports from developed nations did not.

"What may be happening is that trade is stimulating technical progress, which in turn is increasing the demand for skilled labor," the authors write. "It is not simply that patents per worker, or average TFP, increases -- total innovation in the affected firms and industries expands when they face more exogenous threats from Chinese imports." One explanation may be that companies already have certain "trapped factors," such as equipment or firm-specific skills, which they might as well try to use to develop new processes or products. Opening up to trade effectively lowers their opportunity cost of innovation.

At the same time, employment is being reallocated among firms. For every 10 percentage point increase in imports, employment falls 3.5 percent overall in the affected sectors, but this decline is not shared evenly. Highly innovative companies are more likely to grow; less innovative ones are more likely to shrink. A 10 percentage point increase in Chinese imports decreases the probability of survival of European firms by about 17 percent.

To correct for the possibility that unobserved technological shocks affected their results, the authors examine the effects of Chinese imports after China`s entry into the World Trade Organization, which led to the end of import quotas on textiles and apparel. This allows them to study industries that had widely different experiences after trade liberalization and to focus on textiles and apparel: although relatively low tech, they were still the source of more than 22,000 patents from European companies during the period they study. The authors also control for differential industry-specific time trends and exploit the fact that Chinese imports tended to increase where China already had established a "bridgehead" by the mid-1990s. The results support their main conclusion that Chinese trade spurred innovation.

The authors conclude that the surge in Chinese imports was responsible for about 15 percent of European technological change for the whole period from 2000 to 2007, but the impact now seems to be growing stronger. They write that "this effect appears to be increasing over time and may even be an underestimate as we also identify a role for offshoring to China in increasing TFP and IT adoption (although not for innovation). This suggests that increased import competition with China has caused a significant technological upgrading in European firms in the affected industries through both faster diffusion and innovation."

Yet another reason to fight for free trade. An increase of 10 percentage points in Chinese imports in a firm's industry is associated with an increase of: 3.2 percent in patents, 3.6 percent in IT spending, 12 percent in R&D spending, and 2.6 percent in total factor productivity (TFP). Under increased competition from imports the more innovative firms grow while the less innovative ones tend to shrink or disappear. Overall, competition from imports is significantly increasing technological upgrading. This is all to the good.