The rise of the People's Republic of China and its competition effects on innovation in Japan

Yamashita, Nobuaki; Yamauchi, Isamu Working Paper The rise of the People's Republic of China and its competition effects on innovation in Japan ADBI Working Paper Series, No. 939 Provided in Cooperation with: Asian Development Bank Institute (ADBI), Tokyo Suggested Citation: Yamashita, Nobuaki; Yamauchi, Isamu (2019) : The rise of the People's Republic of China and its competition effects on innovation in Japan, ADBI Working Paper Series, No. 939, Asian Development Bank Institute (ADBI), Tokyo This Version is available at: https://hdl.handle.net/10419/222706 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/3.0/igo/ ADBI Working Paper Series THE RISE OF THE PEOPLE’S REPUBLIC OF CHINA AND ITS COMPETITION EFFECTS ON INNOVATION IN JAPAN Nobuaki Yamashita and Isamu Yamauchi No. 939 March 2019 Asian Development Bank Institute The Working Paper series is a continuation of the formerly named Discussion Paper series; the numbering of the papers continued without interruption or change. ADBI’s working papers reflect initial ideas on a topic and are posted online for discussion. Some working papers may develop into other forms of publication. Suggested citation: Yamashita, N. and I. Yamauchi. 2019. The Rise of the People’s Republic of China and Its Competition Effects on Innovation in Japan. ADBI Working Paper 939. Tokyo: Asian Development Bank Institute. Available: https://www.adb.org/publications/rise-prc-and-itscompetition-effects-innovation-japan Please contact the authors for information about this paper. Email: [email protected] Nobuaki Yamashita is a Senior Lecturer, Royal Melbourne Institute of Technology, Australia. Isamu Yamauchi is a Research Associate at the Research Institute of Economy, Trade and Industry (RIETI) and a Junior Associate Professor at Meiji Gakuin University. The views expressed in this paper are the views of the author and do not necessarily reflect the views or policies of ADBI, ADB, its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms. Working papers are subject to formal revision and correction before they are finalized and considered published. This study was undertaken as a part of the project “Mobility of Knowledge and the Innovation Performance of Japanese Firms” at the Research Institute of Economy, Trade and Industry (RIETI) in Tokyo, Japan. For useful suggestions and comments, we would like to thank Yuqing Xing, Matthias Helble, and participants at the ADB workshop. Asian Development Bank Institute Kasumigaseki Building, 8th Floor 3-2-5 Kasumigaseki, Chiyoda-ku Tokyo 100-6008, Japan Tel: +81-3-3593-5500 Fax: +81-3-3593-5571 URL: www.adbi.org E-mail: [email protected] © 2019 Asian Development Bank Institute ADBI Working Paper 939 Yamashita and Yamauchi Abstract This paper empirically examines the “defensive innovation” hypothesis that firms with higher exposure to low-wage economy import competition intensively undertake more innovative activity by using a high quality Japanese firm-level panel dataset over the period 1994–2005. The novel feature of the analysis is the relation of firm-level variations of patent usage to import competition. The results suggest that intensified import competition from the People’s Republic of China has resulted in greater innovative activity by Japanese firms, consistent with the findings of European firms in Bloom et al. (2016). Moreover, such competition has also led to an increase in non-used patents. JEL Classification: O00, F10 ADBI Working Paper 939 Yamashita and Yamauchi Contents 1. INTRODUCTION ......................................................................................................... 1 2. THE RISE OF THE PRC IN WORLD TRADE ............................................................. 2 3. DATA AND VARIABLES ............................................................................................. 6 3.1 Firm-level Patent Data ..................................................................................... 6 3.2 Japan Industry Productivity Data ..................................................................... 7 4. EMPIRICAL SPECIFICATION AND RESULTS .......................................................... 9 5. RESULTS .................................................................................................................. 10 6. CONCLUSION .......................................................................................................... 13 REFERENCES ..................................................................................................................... 14 APPENDIX ............................................................................................................................ 17 ADBI Working Paper 939 Yamashita and Yamauchi 1 1. INTRODUCTION This paper examines the “‘defensive innovation” hypothesis first discussed in Wood (1994) and subsequently formalized in Thoenig and Verdier (2003). As a reaction to import competition from low-wage economies, firms in developed economies would respond by upgrading their innovative activities, leading to “defensive skill-biased innovation.” In a broader context, the effect of competition on the rate of innovation has been one of the most studied areas in the literature (e.g, Aghion et al. 2005). In the study most relevant to our paper, Bloom et al. (2016) found that a large sample of European firms increased a wide range of their innovative activities (patenting, research and development (R&D) expenditures, computer use, and the TFP growth), driven by intensified competition from the People’s Republic of China (PRC). This innovation was conducted within-firm.1 Building on the foundation set by the previously mentioned studies, this paper examines the causal effect of intensified Chinese import competition on the innovative activities of a panel of Japanese firms for the period 1994–2005. We focus on patent usage data as an indicator of innovative outputs. Unlike other studies using patent statistics, this study adds to the literature by exploring strategic patent usage as responses to import competition from a low-wage economy (the PRC). It is generally acknowledged that patent statistics are meaningful proxies for firm-level innovation, but it is well known that firm-level patenting serves as much more than just an indicator of knowledge capital output (Nagaoka et al. 2010). Well-known inventor surveys (e.g., the RIETI-Georgia Tech US-Japan survey) have revealed that many of the patents are not used to introduce new products into the market; instead, they are used as effective strategic instruments to “block” other competitors from innovating or imitating. Boldrin and Levine (2013) present a nice case involving Microsoft — a market incumbent with a stockpile of patents blocking Google in the smartphone market). Studying innovative firms’ responses to Chinese import competition provides an interesting and excellent testing ground for the following reasons: First, over the past decades, the PRC has emerged as a pivotal assembly-export economy of high-tech products (mainly, electronics), importing parts and components from other advanced economies and exporting final products (including the famous iPhone). Accordingly, the PRC’s export bundle has dramatically changed from labor-intensive goods to high-tech products, exerting considerable competitive pressures on firms in developed economies. Second, many Chinese exports compete at lower cost margins than most high-tech products. For instance, a study by Schott (2008 found that the PRC’s export similarity index has become closer to that of Organization for Economic Cooperation and Development (OECD) economies, but the unit prices of Chinese exports have been consistently lower than OECD economies. The finding suggests that Chinese import competition leads Japanese firms to expand their innovative activities, as found by Bloom et al. (2016. The expansion is partly driven by an increase in firms’ numbers of unused patents, which reflect the strategic use of intellectual property (IP) protection. The organization of this paper is as follows. The next section presents an overview of the PRC in world trade. Section 3 discusses the dataset, followed in Section 4 by the 1 Amiti and Khandelwal (2013) find that increased import competition (measured by a decline in tariffs) spurs a economy’s export quality (measured by the market share) in the US market. ADBI Working Paper 939 Yamashita and Yamauchi 2 empirical approach and a discussion of the preliminary findings. Section 5 concludes the paper. 2. THE RISE OF THE PRC IN WORLD TRADE Figure 1-A depicts the rise of the PRC in world exports for the period 1990–2011. In 1990, the PRC’s exports accounted for a tiny share (around 3%) of world exports. Since then, the PRC’s share has gradually increased. In particular, the PRC’s export growth has risen since the early 2000s. In the second half of 2000, the PRC has achieved formidable export expansion by overtaking Germany for the position of the world’s largest exporter, accounting for more than 10% of world exports. The PRC’s export share has been growing without any disruptions, while the world shares of Japan, the United States and Germany have not grown during the same period. At the same time, the PRC has become an important economy in the world important market (Figure 1-B). While the United States still accounts for the bulk of world imports (around 15–20% in world imports), its share has gradually been declining since 2000. By contrast, the PRC’s share has steadily increased to close to 10% in 2011. Figure 1: The Rise of the People’s Republic of China in World Trade, 1990–2011 (% in total exports) Source: UN Comtrade. With the rise of the PRC in world trade, its specialization has dramatically changed, as well. Figure 2 depicts the share of relatively more capitaland technology-intensive products like electrical machinery and household electric appliances as compared to more labor-intensive products like textiles and toys. There has been a notable shift of comparative advantages from more labor-intensive products toward more capitaland technology-intensive products. In 1992, textiles and toys accounted for approximately 45% of the PRC’s total exports. However, this share continuously declined and dropped to close to 20% in 2011. On the other hand, the export share of electrical machinery and household appliances doubled its share, from less than 15% in 1992 to 30% in 2011. In this product category, the export composition is highly concentrated in Information Communication Technology (ICT) products. Other important product ADBI Working Paper 939 Yamashita and Yamauchi 3 categories include office machines, and telecommunications sound equipment (including mobile phones). Based on the income-weighted export bundle of Chinese goods, some commentators argue that this is a sign that the technological capability of the PRC is rapidly converging toward the technological frontier of advanced OECD economies, and is now directly competing with them in the export market. However, this should be interpreted cautiously. Allowing for intra-product specialization, it is known that the PRC’s export specialization still rests largely on the labor-intensive assembly stage rather than specialization in technological content (Athukorala and Yamashita, 2006). In other words, the PRC’s comparative advantages still rests on a labor-intensive segment in high-tech products, even though these products are exported from the PRC (a final assembly economy). This explains why Schott (2008) observes that the unit price of Chinese export bundles are at the lower end of the price range, as compared to those of OECD economies (the price competitiveness coming from the PRC’s lower labor costs). In sum, the bulk of Chinese exports are mass-market commodities assembled with relatively low unit costs and imported high-tech parts and components from other industrial economies (notebook computers, mobile phones). Figure 2: Structural Changes in the People’s Republic of China’s Export Product Compositions, 1990–2011 (% in total exports) Source: UN Comtrade. Table 1 displays the top eight and bottom eight industries by degree of Chinese import competition 1994 (the beginning of the estimation period).2 In the textile industry, where Chinese firms are considered to have comparative advantages, the degree of import competition was already strong in 1994 — of Japan’s import of textile products, 49% came from the PRC. That share continued to increase, reaching 77% in 2005. More strikingly, the largest increase in the PRC’s share of Japanese imports is in office and service industry machines; this share rose from 19% in 1994 to 76% in 2005. 2 Year 1990 data is used in an experimental stage, but the order-import completion-exposed industries are roughly the same in year 1994). ADBI Working Paper 939 Yamashita and Yamauchi 4 Correspondingly, in the industries whereby the PRC’s share increased, there was a decline in the shares of Asian newly industrializing economies (NIEs) — Taipei,China; Hong Kong, China; Republic of Korea; and Singapore) and the US. In the bottom eight industries, an increase in the PRC’s share is palpable, with strong growth in electronic equipment and semiconductor devices. Production networks between Japan and the PRC may explain an expansion in Chinese import in those high-tech industries. Table 1: Change of Import Competition by Source Economies/Groups in Japanese Manufacturing Industry, 1994 and 2005 1994 PRC Asian NIEs SE Asia US Manufacturing, total 11.4 15.9 10.2 25.7 Top 8 sectors in 1994 Coal products 68.9 13.2 0.0 2.7 Textile products 48.7 15.1 8.0 5.6 Miscellaneous ceramic, stone and clay products 34.4 19.1 3.0 13.6 Rubber products 33.4 18.3 10.1 15.7 Leather and leather products 26.5 19.9 5.8 5.2 Electrical generating, transmission, distribution and industrial apparatus 24.4 24.1 19.5 19.6 Pig iron and crude steel 23.7 4.0 3.0 7.0 Office and service industry machines 19.4 16.5 21.6 22.1 Bottom 8 sectors in 1994 Chemical fibers 1.2 48.9 2.7 26.4 Petroleum products 1.0 22.4 12.0 6.2 Electronic equipment and electric measuring instruments 0.6 3.1 0.6 63.9 Pulp, paper, and coated and glazed paper 0.5 1.7 0.9 40.7 Semiconductor devices and integrated circuits 0.4 41.7 8.2 49.1 Printing, plate making for printing and bookbinding 0.4 26.0 1.0 64.7 Tobacco 0.1 0.0 0.0 95.3 Motor vehicles 0.0 0.3 0.0 27.7 2005 PRC Asian NIEs SE Asia US Manufacturing, total 28.6 12.8 10.9 15.2 Top 8 sectors in 1994 Coal products 92.2 1.5 0.0 0.5 Textile products 76.5 3.5 4.0 2.0 Miscellaneous ceramic, stone and clay products 60.4 5.0 3.8 9.6 Rubber products 58.4 6.9 17.2 5.5 Leather and leather products 46.5 1.8 2.7 2.0 Electrical generating, transmission, distribution and industrial apparatus 47.2 8.5 17.2 10.2 ADBI Working Paper 939 Yamashita and Yamauchi 11 These results and associated interpretations are reinforced upon taking an instrumental approach (Table 3). In first stage regression (not shown), labor productivity has a statistical significance that is on the level of Chinese import competition. 14 The estimated coefficients in all regressions now show larger effects as compared to the OLS estimates.15 Table 3: Chinese Import Competition and Patent Usage (IV Regressions), 1994 and 2005 Instrumental Variable (1) (2) (3) (4) (5) PAT USE DEV NON-USE LICENSE CHMjt-5 0.113*** 0.064*** –0.073*** 0.077*** –0.009*** (0.004) (0.004) (0.004) (0.004) (0.001) Constant –1.017*** –0.524*** 0.366*** –0.828*** 0.065** (0.090) (0.091) (0.094) (0.098) (0.030) Firm fixed effects Yes Yes Yes Yes Yes Industry-Year fixed effects Yes Yes Yes Yes Yes N 35,200 35,200 35,200 35,200 35,200 Notes: *** denotes 1% significance; ** denotes 5% significance; * denotes 10% significance. Estimation is by OLS with standard errors clustered by industry. The dependent variable is in five-year log differences of each patent usage type. Chinese imports as a fraction of total industry imports represent an explanatory variable. All columns include a full set of firm and industry-year fixed effects. In Table 4, the empirical specification follows a form of the conventional knowledge production function, treating patents as knowledge outputs. Even after we control for relevant firm characteristics, Chinese import competition remains positive and statistically significant. With respect to firm size (measured by the number of employees), it indicates that smaller firms obtain more patents, and older firms (in terms of the age of the firm) engage in more innovative activity (interestingly, the estimated coefficients for firm characteristics withhold much larger than a variable of capturing the level of import competition from the PRC): a 10 percentage point decrease in employment leads to a 4.4% increase in innovative activity. Other than a PAT regression, we found the effect of Chinese competition to be positive and statistically significant in a NON-USE regression (column 4). Conditioned on relevant firm characteristics, Chinese import competition would produce patents of a more defensive (unused patents) among Japanese firms. Table 5 sequentially introduces the import competition indicators from other economies. We introduced import competition from Asian NIEs (Singapore; Republic of Korea; Hong Kong, China; and Taipei,China) separately for those from high-income OECD economies (including the United States and high-wage European economies). 16 Overall, the main results remain the same: increased Chinese import competition would make Japanese firms pursue more patenting, while import competition from other high-wage economies has no statistical significance. These findings conform to those found in Bloom et al. (2016. The theoretical intuition drawn from the trapped-factor model is that import 14 A full set of tests needs to be carried out to establish the validity of instruments. 15 In Bloom et al. (2016), similar results were obtained. 16 In an experimental stage, import competition from other low-wage economies (such as those in mainland Southeast Asia) was included, but it turns out that it is not important, and does not change the estimated coefficient for CHM. ADBI Working Paper 939 Yamashita and Yamauchi 12 competition from high-wage economies is not a substitute for old products, which do not create incentives for innovation. There is positive and statistically significant effect on non-use patents (NON-USE), while in other regressions, the sign for CHM has been changed or has lost statistical significance as compared to the benchmark estimation. Table 4: Chinese Import Competition and Patent Usage (OLS with Firm-Level Characteristic Controls), 1994 and 2005 (1) (2) (3) (4) (5) PAT USE DEV NON-USE LICENSE CHMjt-5 0.031*** 0.010 –0.012* 0.021*** –0.000 (0.008) (0.007) (0.006) (0.007) (0.001) Log (Emp)it-5 –0.445*** –0.113 0.023 –0.532*** 0.029 (0.096) (0.098) (0.106) (0.098) (0.028) Log(Age) it-5 0.517*** 0.326*** –0.617*** 0.372*** –0.089*** (0.109) (0.110) (0.139) (0.134) (0.029) Log(R&D)it-5 –0.253*** –0.372*** –0.696*** –0.032 –0.069** (0.056) (0.101) (0.118) (0.075) (0.026) Constant 0.276 –0.714 2.564*** 1.307** 0.266 (0.597) (0.589) (0.556) (0.634) (0.165) R-sq 0.398 0.349 0.350 0.301 0.291 N 35,164 35,164 35,164 35,164 35,164 Notes: *** denotes 1% significance; ** denotes 5% significance; * denotes 10% significance. Estimation is by OLS with standard errors clustered by industry. The dependent variable is in five-year log differences of each patent usage type. Chinese imports as a fraction of total industry imports represent an explanatory variable. All columns include a full set of firm and industry-year fixed effects. Table 5: Chinese Import Competition and Patent Usage (OLS with Other Import Competition Variables), 1994 and 2005 (1) (2) (3) (4) (5) PAT PAT USE USE NON-USE CHMjt-5 0.036*** 0.033*** 0.015*** 0.007 0.025*** (0.008) (0.009) (0.005) (0.009) (0.008) NIEjt-5 –0.003 0.005 –0.004 (0.008) (0.008) (0.005) Highjt-5 –0.007 –0.008** (0.006) (0.004) Constant –0.494** –0.144 –0.471* 0.126 –0.351* (0.238) (0.366) (0.233) (0.336) (0.200) R-sq 0.394 0.395 0.346 0.347 0.298 N 35200 35200 35200 35200 35200 continued on next page ADBI Working Paper 939 Yamashita and Yamauchi 13 Table 5 continued (6) (7) (8) (9) (10) NON-USE DEV DEV LICENSE LICENSE CHMjt-5 0.023*** –0.021*** –0.019** –0.002* 0.000 (0.007) (0.005) (0.008) (0.001) (0.001) NIEjt-5 –0.007 –0.002 (0.007) (0.001) Highjt-5 –0.005 –0.000 0.002* (0.008) (0.005) (0.001) Constant –0.170 0.512** 0.365 0.154*** –0.003 (0.408) (0.214) (0.390) (0.032) (0.077) R-sq 0.298 0.342 0.342 0.290 0.290 N 35,200 35,200 35,200 35,200 35,200 Notes: *** denotes 1% significance; ** denotes 5% significance; * denotes 10% significance. Estimation is by OLS with standard errors clustered by industry. The dependent variable is in five-year log differences of each patent usage type. Chinese imports as a fraction of total industry imports represent an explanatory variable. All columns include a full set of firm and industry-year fixed effects. 6. CONCLUSION This paper examined the impact of Chinese import competition on the innovation responses of a panel of Japanese manufacturing firms for the period 1994–2005. Based on the unusually detailed firm-patent dataset, we have uncovered several heterogeneous dimensions of the impact of innovation in the case of import competition from the PRC. First, we found that, while increased imports from the PRC have induced Japanese firms to take out more patents, they are mostly of lower quality (i.e., patents with zero-forward citation). This was inferred as evidence suggesting that Japanese firms have increased the defensive nature of patents in order to protect their core inventions. This is similar to a strategy followed by firms in “continuous” technology-intensive industries in the field of Information and Communication Technology (ICT); to build up the patent fence in order to deter new entrants in the technology field. This finding coincides with a sector that has been subject to intensified import competition from the PRC over the past two decades. Second, when the sample of firms is split into globally-engaged firms with positive importing (and exporting) activity and domestic-oriented firms, the former group has responded positively to import competition from the PRC by increasing its R&D intensity. Our interpretation of this result is that Japanese firms (and presumably more innovative firms) have built up their innovation capacity while moving away from low-cost manufactured goods, in which the PRC has more comparative advantages. In contrast, such effects are consistently muted for firms with a domestic market focus. These types of firms are completely insulated from Chinese import competition. ADBI Working Paper 939 Yamashita and Yamauchi 14 REFERENCES Aghion, Philippe, Nicholas Bloom, Richard Blundell, Rachel Griffith and Peter Howitt (2005). “Competition and Innovation: An Inverted U Relationship,” Quarterly Journal of Economics, 120(2): 701–728. Amiti, Mary and Amit Khandelwal (2013). “Import Competition and Quality Upgrading”, Review of Economics and Statistics. Amiti, Mary, and Caroline Freund (2013) “An Anatomy of China's Export Growth”, in Robert Feenstra and Shang-Jin Wei (eds) China's Growing Role in World Trade, Chicago Press. Ashournia, Damoun, Jacob R. 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ADBI Working Paper 939 Yamashita and Yamauchi 17 APPENDIX Appendix Table 1A: Descriptive Statistics PAT NON-USE USE DEV LICENSE CHM Year Mean Mean Mean Mean Mean Mean 1994 109.1 77.2 35.0 27.9 0.4 10.3 1995 107.2 75.2 32.2 27.8 0.3 12.5 1996 121.1 86.7 34.6 30.7 0.4 13.7 1997 98.6 64.3 34.4 91.7 0.6 15.1 1998 106.4 68.1 38.3 101.2 0.5 16.0 1999 115.2 73.3 41.9 108.8 0.6 16.8 2000 50.2 36.6 24.1 40.7 0.9 18.2 2001 123.3 75.4 47.9 38.9 0.8 20.5 2002 124.3 78.1 46.3 38.8 0.7 23.0 2003 142.5 91.9 50.5 41.4 0.7 24.1 2004 141.9 88.7 53.2 43.1 2.1 26.5 2005 130.9 81.0 49.9 43.2 2.3 28.9 PAT USE NON-USE LICENSE # of Firms Year Sum Sum Sum Sum Sum 1994 46,908 16,118 30,790 200 6,374 1995 49,417 16,300 33,117 79 6,637 1996 53,485 17,650 35,835 300 6,614 1997 53,352 17,600 35,752 800 6,464 1998 52,119 17,200 34,919 228 6,513 1999 55,909 18,692 37,217 247 6,447 2000 43,166 9,800 33,366 344 6,340 2001 50,000 39,726 10,274 938 6,415 2002 47,000 24,670 22,330 301 6,269 2003 48,061 20,155 27,906 350 5,764 2004 47,166 43,000 4,166 8,930 6,088 2005 42,662 34,000 8,662 10,000 5,937 Source: Own calculation. Appendix Table 2A: Descriptive Statistics for Variables Used in Regressions Variable Unit Obs Mean Std. Dev. Min Max PAT Count 75,862 113.8 1,102.1 0 55,909 USE Count 75,862 40.4 433.2 0 43,000 NON_USE Count 75,862 74.5 819.2 0 42,662 DEV Count 75,862 53.1 653.8 0 55,909 LICENSE Count 75,862 0.8 49.3 0 10,000 Emp. total Unit 75,862 629.0 2,424.1 50 80,500 R&D expenditures Value in yen 75,862 888.4 10,266.2 0 527,359 Est. year Year 75,857 1,951.0 111.0 0 2,006 CHM Percentage 75,862 18.6 16.2 0.02 98 Source: Own calculation.