Deep Integration of Export Destinations and Firm Innovation: Evidence from China

Abstract

How do firms in non-member countries adjust their innovation strategies when their export destinations engage in deep integration through preferential trade agreements (PTAs) membership? Using global PTA provisions and Chinese firm-level data, we construct the local exposure of an industry to the deep integration of its export destinations and find it negatively affects Chinese firms' innovation. Various negative trade effects along the intensive and extensive margins substantiate the competition in export destinations, in line with the Schumpeterian effect. We also find that the most productive firms innovate and profit more, whereas the least productive firms innovate less and incur losses, in response to the deep integration of their export destinations, supporting the escape-competition argument. In addition, we show firms' innovation responses to the deep integration of export destinations vary by PTA provisions, China's PTA partnership and patent types. The negative innovation effect, coupled with the deterioration of the terms of trade, suggests potential welfare losses for non-member countries.

Keywords: Innovation, Schumpeterian effect, Escape-competition effect, Preferential trade agreements, Deep integration