The Impacts of Uncertainty, and Asymmetric Induced Innovation on China's Productivity Growth

The volatility of import and capital prices is crucial for export‐oriented economies like China, where key production decisions must often be made before these prices are known. This paper investigates the impact of price uncertainty and induced innovation on China's production sector. We model price volatility by the multivariate autoregressive conditional heteroskedasticity method and embed this within an expected utility maximizing model. This model is further extended by allowing for asymmetric responses to input price changes. Using Chinese annual data, we find that while the parameter of absolute risk aversion is statistically significant, its magnitude is small, suggesting that Chinese producers are risk‐averse but uncertainty does not profoundly affect their production decisions. Our results further reveal significant asymmetry in these decisions; labor demand, for instance, adjusts more aggressively to a wage decline than to a wage increase, suggesting potential irreversibility in producer behaviour. Results also show that the restrictions producing the moment equations are validated, indicating that the selected instruments for correcting potential endogeneity of input demands are appropriate. Regarding the productivity measures, wage‐ and import‐price‐induced innovations are identified as primary drivers of TFP growth, highlighting the important role of trade liberalization in fostering innovation in China.