Innovation and Firm Performance in the People's Republic of China: A Structural Approach with Spillovers

Abstract

We adopt a structural framework to study the process of indigenous innovation and its impact on firm performance in the People’s Republic of China (PRC). In our analysis we use a rich source of panel data comprising almost 70,000 private Chinese firms operating in the PRC from 2004 to 2007. Relying on a structural innovation framework, we estimate the effects of technological learning during each phase of the structural model: (i) the firm’s decision to innovate, (ii) the innovation effort, (iii) the innovation throughput, and (iv) the firm performance. We show that in the early stages of innovation, Chinese firms fail to incorporate learning spillovers into their innovation effort, even when considering their absorptive capacity. Conversely, we found that in the later stages of innovation, learning spillovers positively increase firms’ innovation output as well as their performance, especially for firms with high absorptive capacity.