Does Import Competition Spur Innovations?

What is it about?

We examine the impact of import competition on firms’ innovation input and output. We conjecture that U.S. firms view import competition from high-wage countries (HWCs) as “neck-and-neck” competition and will respond by intensifying innovation. In contrast, U.S. firms will reduce innovation in response to import competition from low-wage countries (LWCs), because such competition does not always increase the potential benefits from innovation. Our empirical results are supportive. We find that, when confronting HWC import competition, U.S. firms increase R&D expenditures, file more patents, receive more citations to their patents, and produce more breakthrough patents. Moreover, U.S. firms closest to the technological frontier—largest firms, firms with the largest stocks of knowledge, and most profitable firms—intensify innovation the most in response to HWC competition. These results shed light on the relationship between product market competition and innovation, and on the impact of trade on firm performance.

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Why is it important?

Our paper contributes, first, to the literature on the relationships between product competition and innovation. To the best of our knowledge, our paper is the first to decompose market competition into different spectrums and finds that firms, depending on their industry positions, responds to different competition differently. It complements recent efforts to examine heterogeneity in technological levels among incumbent firms (Lee 2009, Tang 2006). Recent papers find that European firms facing import competition from China normally increase innovation (Bloom et al. 2012), but European firms lagging far behind U.S. firms in terms of technology capabilities reduce innovation when faced with import competition (Aghion et al. 2009). Such results will be difficult to reconcile without differentiating between the technological capabilities of firms in the importing countries and their competitors in the exporting countries. Imports from HWCs may represent more comparative technological advantage to U.S. firms than imports from LWCs. Hence, U.S. firms face more technological competition when import competition from HWCs (rather than LWCs) increases. As a result, the impact of HWC and LWC imports on innovation will be different. In addition, this paper studies not only innovation input (R&D) and output (patents) in terms of quantity, but also the quality and novelty of patents, thereby connecting the competition¬–¬innovation literature with the emerging literature on radical inventions and highlighting one circumstance under which existing firms become a source of radical inventions (Ahuja and Lampert 2001, Eggers and Kaul 2014). Finally, although it has been widely documented that patents tend to be concentrated in large firms (e.g., Nanda et al. 2013), our study highlights one of the circumstances in which large firms enhance competitive advantage against small firms. Our paper also contributes to an emerging literature on import competition from LWCs and firm performance. While much has been found about how trade with LWCs has depressed wages and employment in the U.S. (Autor et al. 2013, Bernard et al. 2006, Ebenstein et al. 2014), little attention has been paid to the impact of import competition from LWCs on firms’ innovation. This paper illuminates how innovation by domestic firms varies in response to trade with different countries.