Make or Buy? Trade-Induced Shifts in Firms' Innovation Behavior

Abstract

Using Japanese firm-level data over 2000--2008, we show that Chinese import competition reorganizes firm innovation rather than simply reducing it. Exposed firms shift from internal innovation (``Make'') toward arm's-length acquisition of patented technologies (``Buy''), with no statistically detectable net change in total patent activity. This recomposition is not a simple budget-driven substitution: highly leveraged firms substitute more sharply, consistent with greater exposure to the downside risk of internal R\&D, while financial slack governs the scale of Buy-side expansion. The shift is associated with weaker subsequent TFP growth, indicating that the organization of innovation matters for the productivity effects of trade shocks. A partial-equilibrium model rationalizes these patterns through the asymmetric risk structure of the two modes.

Keywords: Import competition, Innovation, Make-or-buy, Patent transactions