Saturday, January 22, 2011

Will Chinese Import Competition Nudge Our Firms to "Raise their Game"?

Here is an important new NBER paper.  I didn't write it!   Take a look at how people responded to my NY Times "Room for Debate" piece last week. You can read it here.   Many of the folks who wrote "nice" comments about my post appear to believe that we are in a zero sum game with China.  But, in a world where ideas are public goods and in which low input prices increase the competitiveness of many of our firms, international trade continues to offer benefits both to us as consumers (think of Walmart without Chinese imports) and as producers!   Direct competition forces a nation's firms to innovate and stay cutting edge.  This paper presents new empirical evidence on this point.  


Nicholas Bloom
Mirko Draca
John Van Reenen


We examine the impact of Chinese import competition on patenting, IT, R&D and TFP using a panel
of up to half a million firms over 1996-2007 across twelve European countries. We correct for endogeneity
using the removal of product-specific quotas following China’s entry into the World Trade Organization.
Chinese import competition had two effects: first, it led to increases in R&D, patenting, IT and TFP
within firms; and second it reallocated employment between firms towards more innovative and technologically advanced firms. These within and between effects were about equal in magnitude, and appear to account for around 15% of European technology upgrading between 2000-2007. Rising Chinese import competition also led to falls in employment, profits, prices and the skill share. By contrast, import competition
from developed countries had no effect on innovation. We develop a simple “trapped factor” model
of innovation that is consistent with these empirical findings.

So, this Bloom et. al. paper supports my view that Chinese Import Competition leads domestic firms in rich countries to invest more in ideas and breakthroughs  BUT it also lends empirical support (See Table 5 column 2) to the claim that Chinese imports "cost us jobs".  We should all read and debate this paper's implications.

My read of this paper is that it highlights how diverse firms within the same industry respond to an external shock. In this case, the shock is increased Chinese import competition.  Some "dinosaur" incumbent firms can't compete with the new entrants and they go bust.  Other firms are more nimble and have more adaptation strategies that they can engage in to try to cope with the new reality of intense competition. Such firms may have better management or a more innovative friendly corporate culture that leads them to "raise their game" in response to the Chinese competition.

This Industrial Organization issue of how diverse firms respond to the same challenge has been on my mind as I've been thinking about how environmental regulations such as California's AB32 or the Green Chemistry Initiative can create "winners" and "losers" within the same narrowly defined industry.  Exogenous shifts in regulation or in competition cause a shake up of the status quo.  Is all change bad?