Jan Bena and Elena Simintzi
Review of Finance, Volume 29, Issue 6, November 2025, Pages 1619–1661, https://doi.org/10.1093/rof/rfaf040
China’s economic opening transformed global production, with far-reaching consequences for the U.S. economy. While the literature has emphasized the impact of import competition from China on the U.S. labor market, this paper examines a different mechanism: how U.S. offshoring to China driven by its sheer labor supply and lower labor costs reshaped U.S. firms’ innovation strategies. We show how access to China’s labor market impacted U.S. multinational firms’ technology decisions, specifically, their composition of innovation.
We create a novel measure, where we decompose innovation into processes and non-processes. Process innovation refers to an improvement of a firm’s own production methods lowering production costs. Non-process innovation typically involves Improvement sold to others—consumers or downstream firms—such as new products. The share of process innovation captures the share of firms’ R&D directed toward internal production efficiency. We further match Chinese subsidiaries with foreign ownership from the Chinese Industrial Survey (CIS) to U.S. parent firms in Compustat, enabling us to identify U.S. multinationals with manufacturing production in China.
We find a striking pattern: Figure 1, Panel A, plots our measure of Process innovation share for all publicly listed firms between 1975 and 2010. The share of process innovations started to increase sharply in late 80s/early 90s, which coincides with the polarization patterns of the U.S. labor market largely attributed to the wide adoption of technology (e.g., Autor et al., 2003; Autor, 2010)—a trend that stops starting at year 1999. Our results attribute the reversal of this trend to U.S. firms’ ability to offshore production in China as suggested by Figure 1, Panel B.
Our hypothesis is that U.S. firms primarily lower production costs through two channels: substituting Chinese for U.S. labor and investing in cost-reducing production technologies. To identify causal effects, we exploit a policy-related natural experiment: the 1999 U.S.-China bilateral agreement. By reducing contractual frictions, ownership restrictions, and uncertainty for U.S. multinationals investing in China, the agreement effectively lowered labor costs for these firms, thereby dampening their incentives to invest in cost-saving innovation in the U.S. Consistent with this argument, we find that U.S. firms with Chinese operations significantly reduced process innovations relative to comparable U.S. multinationals without Chinese affiliates—including those with operations in other low-wage Asian countries.
The paper’s central insight is that offshoring to China allowed U.S. firms to cut costs by shifting production abroad rather than investing in automation at home. By uncovering a previously overlooked link between labor sourcing and innovation composition, we highlight the nuanced ways in which globalization shapes the trajectory of technological progress in advanced economies. Our findings suggest that offshoring production to China may have eroded the long-term comparative advantage of U.S. firms by weakening incentives to invest in domestic internal production efficiency.
References:
Autor, D. (2010). The polarization of job opportunities in the US labor market: Implications for employment and earnings. Center for American Progress and the Hamilton Project, 6:11–19.
Autor, D. H., Levy, F., and Murnane, R. J. (2003). The skill content of recent technological change: An empirical exploration. Quarterly Journal of Economics, 118(4):1279–1333.