Trade Policy Uncertainty and Innovation: Evidence from China

This paper studies the effect of resolving trade policy uncertainty on investment in innovation in China during 1990-2007. It exploits exogenous and heterogeneous exposure to tariff uncertainty resolution arising from a major change in US trade policy, which eliminated the possibility of tariff increases on Chinese imported goods, and detailed data on innovation from all sectors and countries in a triple difference-in-differences. Eliminating tariff uncertainty has an economically and statistically significant effect on innovation, and this effect represents actual innovation, rather than just more patent filings. Next, the paper studies the mechanisms that led to this positive innovation response and shows i. that the timing is heterogeneous: high-quality and high opportunity cost innovations respond more slowly and gradually, while lower-quality innovations react quickly; ii. that the increase in innovation reflects a response on three margins: the introduction of patents in new technologies, patents with increased technological scope, and patents in a firm’s pre-period technology portfolio; iii. that relatively more exposed sectors exhibit a larger increase in the number of firms patenting for the first time; iv. that the increase in innovation is at least in part driven by exports to the US.