The trade war has wrecked Chinese Innovation

This paper investigates the effect of the US–China trade war on corporate innovation. We focus mainly on the US tariff shock and explore the Chinese retaliatory tariff shock in further tests. Using a unique and comprehensive data set of Chinese A-share listed firms from 2014 to 2021, on average, we find that increases in tariffs resulting from the trade war hinder corporate innovation in China. The negative relation between the trade war and corporate innovation is robust for the parallel trends test, the placebo test, and a set of robustness checks.

We also examine underlying mechanisms by which the trade war affects corporate innovation. The results show that market expansion and innovation input act as the underlying channels; that is, the trade war leads to reductions in market expansion, input capital, and labor of innovation, eventually hindering corporate innovation.

We further explore invisible factors shaping firm innovation during the trade war. Although the trade war leads to a decrease in patent applications and invention patent applications on average, some firms have incentive to engage in more innovation during the trade war. We find that firms with developed managerial ability, more confident managers, and better CSR performance tend to increase innovation for competitiveness in response to the trade war.

Moreover, we conduct cross-sectional analyses in terms of industry- and firm-level characteristics. We find that the negative relation between the trade war and corporate innovation is more pronounced for firms connected to the United States, suffering financial distress, and for non-SOEs. Finally, we explore the effect of the Chinese retaliatory tariff shock on corporate innovation. We find that Chinese retaliatory tariffs also inhibit corporate innovation in China, again providing evidence that the US–China trade war hampers progress in China's economy and technology.

We contribute to the literature on the economic consequences of the trade war. Our study is related to studies that explore the effect of the trade war on firm exports and performance. Due to differences in data and indicators, the evidence on the causal relation between the trade war and exports in China is mixed. There are studies showing that the trade war has little impact on Chinese total exports. At the product level, Jiang et al. (2023), for instance, argued that though the trade war on average decreases Chinese total exports to the United States, Chinese total exports to the world are hardly affected due to export diversion to other countries. At the industry level, however, they find that the trade war leads to economic losses in firms, which provides evidence for the adverse effect of the trade war. By comparison, some studies demonstrate the negative effect of the trade war on Chinese exports. Using proprietary firm-level data in a Chinese prefecture-level city, Jiao et al. (2022) found that Chinese firms’ total exports and total sales decreased during the trade war because firm exports to the United States significantly dropped, but exports to non-US countries hardly changed. In line with Jiao et al. (2022), based on Chines listed firm data, our study shows that Chinese firms’ total overseas sales and cash flows decreased during the trade war. The decrease in market expansion is an important channel by which the trade war impedes corporate innovation.

Collectively, we provide evidence for the adverse effect of the trade war on Chinese firms. On average, we find that the trade war leads to a decrease in sales, exports, patents, and invention patent applications.