Machines Could Not Compete with Chinese Labor: Evidence from U.S. Firms’ Innovation

Abstract

We study how an improvement in contracting institutions due to the 1999 U.S.-China bilateral agreement affects U.S. firms' innovation. We show that U.S. firms operating in China decrease their process innovations-innovations that improve firms' own production methods-following the agreement. We obtain the same result using the inter-temporal variation in ownership restrictions on foreign investment in China across industries. These findings suggest that a better ability to source labor cheaply across borders affects the types of technologies that are being developed-less process innovation aimed at reducing production cost. More broadly, a decrease in the effective price of labor due to the removal of frictions affects the direction of corporate innovation.

Keywords: process innovation, technological change, labor, China

JEL Classification: O33, J31, L23