U.S.-China trade conflicts and R&D investment: evidence from the BIS entity lists

The U.S.-China trade conflicts, starting in early 2018, significantly impacted both economies. Previous research primarily focused on the macroeconomic effects of tariffs on the U.S., with limited micro-level evidence on China. This study addresses this gap by examining the impact of U.S. export controls, specifically the BIS Entity List and Military End User List, on the R&D investment of Chinese manufacturing firms. The main research question is: How do U.S. export controls affect R&D investment and innovation in Chinese firms? Understanding this impact is crucial for assessing the long-term economic consequences of the trade war and informing policy responses. The study utilizes a quasi-natural experiment design, leveraging the staggered implementation of export controls as an exogenous shock to Chinese firms. This allows for a causal inference on the relationship between export controls and R&D investment, providing valuable insights into the microeconomic impacts of the trade conflict.

Existing literature examines the macroeconomic consequences of tariffs and trade conflicts, showing negative impacts on consumer welfare and prices in the U.S. However, micro-level studies on the impact of export controls on Chinese firms are scarce due to data limitations. Previous research highlights the importance of imported technologies for productivity and innovation, particularly in developing economies. There are conflicting views on the effects of import liberalization on domestic innovation. Some studies suggest that import liberalization hinders innovation by providing readily available substitutes, while others emphasize the potential for import liberalization to stimulate innovation. This study attempts to resolve this ambiguity by focusing on the impact of export controls, which restrict access to imported technologies, on Chinese firms' R&D investment and innovation. The study considers both the potential for increased domestic innovation as a response to import restrictions, and the potential negative impacts of technology blockage. The authors hypothesize that U.S. export controls will stimulate R&D investment in Chinese firms, particularly through government subsidies, inventory adjustments, and increased risk-taking.

The study employs a difference-in-differences (DID) approach using panel data on Chinese A-share listed manufacturing companies from 2013 to 2022. The data on sanctioned firms were manually collected from the BIS Entity List and Military End User List. The dependent variable is the ratio of R&D expenditure to total assets, front-loaded by one year. The key independent variable is a dummy variable indicating whether a firm or its affiliates are on the sanction lists. Control variables include firm size, age, profitability, growth, leverage, cash flow, tangible assets, largest shareholder's shareholding, Tobin's Q, CEO duality, and state-owned enterprise status. The authors address potential endogeneity concerns by including firm and time fixed effects and high-dimensional fixed effects at the industry-by-year level to control for industry-level time-variant factors, and cluster standard errors at the industry level. Dynamic effects are analyzed by including year-specific dummy variables. A placebo test is conducted using randomly assigned treatment variables to assess the validity of the findings. Mechanism tests are performed by examining the mediating effects of government subsidies, non-finished goods inventory, and firm risk-taking. Robustness tests involve expanding the sample to include firms sanctioned by other U.S. departments, applying the Callaway and Sant'Anna estimator to account for heterogeneous treatment effects, and analyzing the impact of tariffs separately. Heterogeneity analysis is performed based on firm ownership (SOEs vs. POEs), executives' foreign experience, and industrial policy support. The study also investigates the impact of export controls on innovation outputs (patent applications).

The DID estimations show a significant and positive effect of U.S. export controls on Chinese firms' R&D investment intensity. Specifically, the R&D investment ratio increases by 16.58% (e^0.274 -1 = 16.58%) in the year after being added to the entity lists. This effect is robust to various robustness checks, including expanding the sample to include other sanction lists, using the Callaway and Sant'Anna estimator, and excluding tariff effects. Mechanism analysis suggests that government subsidies, increased non-finished goods inventories, and heightened risk-taking significantly mediate the relationship between export controls and R&D investment. Heterogeneity tests reveal that the positive impact of export controls is stronger for state-owned enterprises (SOEs), firms with executives having foreign experience, and firms supported by China's industrial policy. Interestingly, however, there is little to no effect on firms' innovation outputs (number of patent applications), suggesting that while R&D inputs increase, the conversion efficiency of R&D inputs to outputs might be low.

The findings support the hypothesis that U.S. export controls lead to increased R&D investment in Chinese firms. The increase in R&D investment is likely a response to the challenges posed by restricted access to imported inputs and technologies. The significant role of government subsidies highlights the importance of policy support in mitigating the negative effects of export controls and fostering domestic innovation. The finding that the positive effect is more pronounced for SOEs suggests that these firms might be better positioned to leverage policy support and access resources to invest in R&D. The results highlight the complex relationship between trade policies, innovation, and firm-level responses in a developing economy. While export controls stimulate R&D investment, they do not necessarily lead to improved innovation outputs, indicating the need to focus on improving the conversion efficiency of R&D inputs into marketable innovations.

This study provides micro-level causal evidence on the impact of U.S. export controls on Chinese firms' R&D investment. The findings show that while export controls stimulate R&D investment, they have a limited or even negative effect on innovation outputs. Future research could explore the long-term consequences of these controls on technological advancement and industry competitiveness in China. Further research is needed to understand the mechanisms of converting R&D investments into tangible innovation outputs. Also, additional research could investigate how firms strategically adapt their R&D activities to different types of export controls and government policies.

The study relies on firm-level data from Chinese A-share listed companies, which may not fully represent the entire population of Chinese manufacturing firms. The time frame of the study is relatively short, limiting the ability to assess long-term effects. The focus on R&D investment as a proxy for innovation might overlook other aspects of innovation, such as process innovation. The assumption of exogenous treatment effects might be challenged by unobserved factors influencing both the imposition of sanctions and firms' R&D investment decisions.