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A Side Effect of Imports: They Encourage Homegrown Innovation

Matt Palmquist

Matt Palmquist is a freelance business journalist based in Oakland, Calif.

 

Bottom Line: Large U.S. firms react to competition from high-quality foreign importers by investing more in their own R&D efforts and producing more patents.

In articles about and analysis of the U.S. economy, technological breakthroughs and cutting-edge systems get most of the ink. The value of innovation to economic vitality and growth tends to monopolize the narrative, and researchers have spent an inordinate amount of time figuring out why some companies invest more heavily than others in innovative efforts. For example, empirical evidence suggests that larger companies with more cash flow and a broader scope of operations tend to spend more on R&D and file more patents than their smaller competitors.

But most of the studies are rather insular, viewing U.S. companies through a relatively narrow and regionally shortsighted lens. As a result, they fail to capture the full picture. Indeed, despite the inexorable impact of globalization on the business landscape, little attention has been paid to the relationship between U.S. firms’ innovative activity and the level of competition they face from abroad.

A new study attempts to address this by exploring the innovation behavior of U.S. companies whose product lines are affected by imports. This is a particularly ambitious piece of research because the authors differentiated between two types of importers: those based in low-wage countries (emerging economies with an annual per capita GDP of less than 5 percent that of the U.S.) and the rest, or the high-wage nations. By making this distinction, the authors could comprehensively examine the impact of different types of competitors on the quantity, quality, and strategic direction of firms’ innovative activities. They found that import origin is an underappreciated but crucial determinant of the commitment to innovation made by U.S. companies.

Import origin is an underappreciated but crucial determinant of the commitment to innovation made by U.S. companies.

Combining several databases, the researchers analyzed the accounting returns, industry-wide import and export statistics, and patent records for the period from 1976 through 2005 (the most recently updated year in the National Bureau of Economic Research’s patent database) of a sample of almost 5,000 publicly listed firms in a variety of manufacturing sectors. The companies in the sample had average assets of US$1.5 billion, annually spent slightly more than 8 percent of their asset value on research and development, and filed an average of 13 patents per year. In addition, on average, each company’s previous patents were cited by other firms in 105 separate applications, a key indicator of the quality of innovative activity (because citations signal that the patent contained ideas critical to subsequent technological advancement).

To measure the comparable degree of competition from international trade a firm faced, the authors calculated the ratio of U.S. imports in the company’s industry to the total value of those products purchased by U.S. consumers. For example, if imports of Widget A totaled $1 billion and people spent $10 billion on Widget As, the ratio was .10; if the imports amounted to $2 billion, it would be .20. Cognizant of the long-term nature of innovative ventures, the authors tied firm characteristics and industry-wide import competition in a given year to the number of patents granted to a company three years later.

When faced with increased levels of import competition from firms in high-wage countries, companies — especially the largest, most profitable firms with the highest number of patents on the books — tended to increase their R&D budgets while improving and intensifying their innovative output. And the effect was significant: On average, the authors calculated that a 10-percentage-point rise in import competition from high-wage nations motivated affected companies to boost their R&D expenditures by about 7 percent and the number of patents they filed by more than 5 percent. Moreover, the patents filed by these companies received more citations from other innovative firms and tended to be more novel or breakthrough in nature.

On the other hand, a 10-percentage-point increase in the level of imports from low-wage countries led the typical firm to cut back on its R&D spending by about 13 percent and generate fewer patents as a result. Because the perception is that import competition from these countries is driven by vast pools of inexpensive labor and not technological gains or capabilities, innovation holds less appeal for U.S. firms facing this scenario. These U.S. companies — especially those already lagging behind their domestic competitors — will likely compete on other fronts, such as supply chain streamlining and lowering product prices.

“Taken together, these findings support our arguments that import competition from [high-wage countries] is more like ‘neck-and-neck’ competition, which incentivizes firms, and especially leading firms, to increase innovation effort to stay ahead,” the authors write. “In contrast, import competition from [low-wage countries] is more like laggard competition, which does not prompt the industry leading firms to innovate.”

The results also suggest that managers should stop viewing foreign competition as purely an issue of market share, and should instead start factoring imports into their long-term innovative strategy. To compete, or even survive, means to stay ahead of international rivals, the authors argue. Managers should also closely monitor the effects of imports on their suppliers. Because multinational firms outsource an increasing amount of production to firms in low-wage countries, their domestic partners could fall behind in innovative capacity, which could have dangerous ripple effects up and down the supply chain.

Source:Does Import Competition Spur Innovations?” by Xiaoyang Li (Cheung Kong Graduate School of Business) and Yue Maggie Zhou (University of Michigan), Ross School of Business Working Paper No. 1299, Dec. 2015 

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A Side Effect of Imports: They Encourage Homegrown Innovation