Does Import Competition Reduce Domestic Innovation? Evidence from the China Shock and Firm-level Data on Canadian Manufacturing

A key economic issue in Canada is the declining business research and development in manufacturing since the early 2000s. Accompanying this, total factor productivity (TFP) growth in manufacturing slowed after 2000. To deepen our understanding of this phenomenon, we focus on the increasing Chinese import share in the total domestic absorption in Canadian manufacturing since the early 2000s, which appears to be driven by positive supply shocks within Chinese manufacturing. Based on firm-level data in Canadian manufacturing, we find that rising Chinese import competition led to declines in R&D expenditure and TFP growth within firms but reallocated employment towards more productive firms and induced less productive firms to exit. The negative within-effects were pronounced for firms that were initially smaller, less profitable, and less productive. At the aggregate level, the positive reallocation effects on TFP more than offset the negative within-effect. We estimate that, had there been no increase in Chinese import competition between 2005 and 2010, TFP in Canadian manufacturing would have declined by 1.26 per cent per year instead of the actual 1.09 per cent per year over this period.