Product Innovation, Export and FDI

Abstract

This paper explores the inter-connection between domestic firms’ product innovation, export, and the presence of FDI. We first set up a theoretical model, where heterogeneous firms, in a monopolistically competitive market, first make decision on product innovation, and then set prices for their products in both domestic and foreign markets. Under mild assumption, the theoretical model generates a set of population moments, which are taken to the data of eight three-digit manufacturing industries in China. We find evidence that firms’ product innovation is positively correlated with their export revenue, and the presence of FDI affects firms’ product innovation and export behaviour both directly and indirectly (via its impact on product innovation), albeit not in all industries. The findings have significant implications to policymakers in not only China, but also other developing countries.

Keywords: Firm Heterogeneity, Sorting Pattern, Product Innovation, Export, FDI, China

JEL Classification: F14, O31, L20, D22