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Competition from China reduced Innovation in the US

Via Tyler Cowen, here is a piece by David Autor, David Dorn, Gordon Hanson, Gary P. Pisano and Pian Shu.

Cowen quoted the most important part, so let me follow his lead:

The central finding of our regression analysis is that firms whose industries were exposed to a greater surge of Chinese import competition from 1991 to 2007 experienced a significant decline in their patent output. A one standard deviation larger increase in import penetration decreased a firm’s patent output by 15 percentage points. Using data from the 1975 to 1991 period and a regression setup that accounts for the diverging secular innovation trends in computers and chemical, we confirm that firms in China-exposed industries did not already have a weaker patent growth prior to the arrival of the competing imports.

…The innovation activity of US firms did not merely shift from the US to other countries. We estimate similar negative effects of import competition on patents by US firms’ domestic employees and by their foreign employees. Instead, our results are most consistent with the notion that the rapid and large increase in competition squeezed firms’ profitability and forced them to downsize along many margins, including innovation. Consistent with that interpretation, we find that the adverse impact of import competition on patent output was concentrated in firms that were already initially more indebted and less profitable.

Here’s what I think is happening. Chinese imports typically enter a market from the bottom, with a low price and a reputation for low quality. After a few years, the quality begins to improve, though it takes somewhat longer for the reputation to follow.

From the perspective of incumbent players, the Chinese don’t play at the top of the market where the high margin flagships are, but they take up a lot of market share in the lower end products. But, though broadline products have slim profit margins, they keep the plants operating at capacity, and that’s what covers capital costs.

So… the existential threat to the incumbents comes from having higher costs than the new competitor. The natural reaction then, is to cut costs. Fire people, idle plants and reduce expenses like marketing and R&D.

Despite Schumpeterian theory, many of the most innovative (large) companies in post-WW2 America were monopolies or awfully close to it. Think Bell Labs, Xerox Parc or Skunk Works (i.e., Lockheed’s Advanced Development Projects) for classic examples from back in the day. Ma Bell could afford the time and money needed to do world-class research.  Today’s phone companies cannot. Smaller companies have other dynamics, and often they are the source of innovation in many industries.  Smaller innovators whose technology proves successful end up being bought (and sometimes ruined) by the more established players.

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