An Innovation Puzzle in China: Does Knowledge Inflow Matter after the Trade War?

This paper explores a puzzle in China's innovation performance, where innovation output experienced a sharp turnaround in 2018 despite the rising technology market and R&D investment by Chinese firms. We investigate the impact of three rounds of tariffs imposed during the U.S.-China trade war on Chinese firms' innovation performance. Using a Difference-in-Differences approach and textual analysis techniques, we find that the first round of tariffs significantly reduced knowledge inflows from the U.S. through the learning-by-exporting process, leading to a decrease in the quantity and quality of innovation by Chinese firms. This effect was particularly pronounced for technology frontier firms. We also rule out the market size and R&D investment as potential channels for the impact of U.S. tariffs on Chinese firms' innovation. Our findings contribute to the literature on the relationship between trade and innovation.