Can Investment Incentive Crowd Out Innovation? Evidence from China

51 Pages Posted: 3 Oct 2019 Last revised: 1 Feb 2021

See all articles by Shaowei Ke

Shaowei Ke

University of Michigan at Ann Arbor - Department of Economics

Yao Lu

Tsinghua University - School of Economics & Management

Xinzheng Shi

Tsinghua University - School of Economics & Management

Yeqing Zhang

Central University of Finance and Economics (CUFE); Tsinghua University, School of Economics & Management, Students

Date Written: February 1, 2021

Abstract

We analyze the spillover effect of a fixed asset investment incentive on firm innovation by estimating the influence of China’s value-added tax reform in 2004 with a difference-in-difference-in-differences approach. We find that a fixed asset investment incentive significantly reduces firm innovation. In a simple model, we show that the reduction could arise because some firms choose to upgrade their technology given the investment incentive, and the upgrade crowds out innovation. Consistent with the predictions, we find that this negative effect is evident in firms with intermediate-level financial constraints but not in firms with tight or loose financial constraints. Moreover, firms with intermediate-level financial constraints increase their fixed asset and intangible asset investments after the reform while other firms do not. Innovation is a major economic growth driver with positive externalities. Thus, investment incentives may lead to some unintended consequences.

Keywords: Innovation; investment tax credit; fixed asset investment; financial constraint

JEL Classification: O31, O32, G31

Suggested Citation

Ke, Shaowei and Lu, Yao and Shi, Xinzheng and Zhang, Yeqing, Can Investment Incentive Crowd Out Innovation? Evidence from China (February 1, 2021). Available at SSRN: https://ssrn.com/abstract=3459276 or http://dx.doi.org/10.2139/ssrn.3459276

Shaowei Ke (Contact Author)

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States

Yao Lu

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

Xinzheng Shi

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

Yeqing Zhang

Central University of Finance and Economics (CUFE) ( email )

39 South College Road
Haidian District
Beijing, Beijing 100081
China

Tsinghua University, School of Economics & Management, Students ( email )

Beijing
China

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