How innovative US manufacturers outcompete Chinese imports?
Industry in the US suffers from intense competition with Chinese imports. Now, Johan Hombert and Adrien Matray, show how investment in R&D and innovation is making American products better, different, and more competitive in a globalized world.
The emanating shockwaves of China’s economic rise go beyond global economic upset. Business in the west has been overwhelmed by competition from China and other emerging economies, with resulting declines in growth, profitability and job cuts. These effects are linked to societal upheaval and political backlash across the US and Europe. This western problem seems hard to solve, but is there a way that countries like the US can compete with Chinese imports?
Is innovation really the answer?
“The US has suffered greatly from the adverse effects of competition from China,” notes Professor of Finance Johan Hombert. “This has led to a decline in industry and a loss of blue collar jobs. Recent political events in the US are thought to be a consequence of this downturn.” The conventional wisdom in response to this dilemma is innovation – innovation is the key to outcompeting foreign imports. Along with co-author Adrien Matray, Hombert pioneered a study that investigates the truth behind this. He notes, “There are firms that have innovated, climbed the quality ladder and differentiated themselves to rise above the competition, but are these the exception or the rule?”
Measuring the impact of innovation on competitiveness
US research and development (R&D) tax credits have been available to industry and manufacturers since the 1980’s. These are specific to each state, with some more or less generous than others. Hombert and Matray saw this situation as an ideal natural laboratory for them to investigate the effect of firm investment in R&D and innovation on competitiveness.
We saw that, in states with large tax credits, firms do more R&D"
The team looked at the changes made to R&D tax credits in the US over time. In addition, they also investigated how Chinese imports had penetrated the US market.
“We saw that, in states with large tax credits, firms do more R&D,” notes Hombert. “The innovation that ensues is a direct effect of the tax credits available. It is not a result of the firms being better organised, managed or having a more skilled workforce. So, their profitability and ability to compete with Chinese imports can be directly compared with that of firms who are not innovating.”
Innovation provides significant competitive advantage
Hombert and Matray found that US firms that had invested more in R&D outcompeted Chinese imports significantly better than firms that invested less in R&D. In many cases, when there was an increase in competition from China, innovating US firms were able to completely offset the losses in profitability experienced by their US counterparts who failed to innovate.
Key to fostering innovation is a well-trained, well-educated workforce."
“The firms that innovated created products that differentiated themselves from low-cost Chinese products. They were both better and different – so they could compete successfully.” This finding is in keeping with the general school of thought that, to get ahead, firms need to innovate. It also supports the idea that, to stand up against competition from Chinese imports, US products do not have to compete in terms of price. Instead, they must be of higher quality and offer something more.
The duo confirms that innovation by US firms can lead to the creation of products that can contend with Chinese imports – and come out on top – not only because they are better but also because they are different.
Based on an interview with Johan Hombert, on his paper “Can Innovation Help U.S. Manufacturing Firms Escape Import Competition from China? (TBC, 2018), co-authored with Adrien Matray.
When it comes to competitiveness, this study shows that investment in industry R&D is key.
Prof. Hombert's Opinion
In the US, President Trump’s administration has recently slashed taxes in the hope that industry will be attracted back and that US products will compete with cheaper foreign products. However, Hombert argues that his recent study provides evidence that this is the wrong strategy in a globalized economy: “Becoming a global competitor cannot be achieved by an across the board reduction in taxes – when you reduce taxes, you reduce government revenue, and then you have to reduce spending in many areas.
Governments have an important role here and must design fiscal policy that helps firms innovate and do better in the modern globalized world,” says Hombert. One such area that often loses out in times of austerity - is education. However, key to fostering innovation is a well-trained, well-educated workforce. “For innovation to continue, governments must invest heavily in higher education,” Hombert adds. He stresses, “Policy makers in the US and Europe are under pressure to close boarders and protect economies from globalization. But there is another way to overcome the challenges posed to them by globalisation: innovate to be better equipped for global competition.
”When it comes to businesses, they are aware of the importance that innovation can have for profitability. This work now provides hard evidence in support of this conventional wisdom. Hombert adds, “Innovation is particularly important when firms face competition from an emerging economy in a globalized world.”
Hombert and Matray investigated the effect of firm investment in R&D and innovation on competitiveness. US R&D tax credits specific to each state provided them with an ideal natural laboratory to develop a model of the interplay between innovation and import competition. The team compared changes to state R&D tax credits and the penetration levels of Chinese imports over the same period of time. They found that R&D tax credits (which directly increase investment in innovation) help US companies to outcompete Chinese imports.