Trade policy uncertainty and corporate innovation —Evidence from the US-China trade war

Abstract

This paper investigates the impact of trade policy uncertainty on corporate innovation, by exploiting the exogenous shock from the US-China trade war starting in 2018, which substantially increases the trade policy uncertainty (TPU) for firms in China. Using the propensity score matching and difference-in-differences approach, we find that Chinese firms with more foreign sales generate less innovation outcomes following the trade war, as measured by patents and citations, with less patent originality and exploration. The effect is more pronounced for firms with less government subsidies and less tax benefits, for firms with greater financial constraints and less cash holding, and for firms with higher customer concentration. Further analyses show that liquidity concern and the cost of capital are the main channels, through which TPU exposure affects innovation.