Explanatory Framework

Basing on the consideration that innovation is the output of production process where knowledge is an input, an explanatory framework is constructed where knowledge originated from three levels flows to firm through different spillover mechanisms (Figure 3. 2).

Individual firms are at Level-1. Firms are heterogeneous in their internal characteristics and thus possess unequal internal knowledge capacity. We summarize six firm-specific variables to account for the firm-level effect. Age and size are the most frequently used firm attributes. According to industrial organization and organizational ecology literatures, age represents the amount of firm’s experience in learning and size indicates firm’s scale advantage. Therefore, older and larger firms are likely to possess excessive amount of resource base, wider access to information and greater opportunity to innovation. However, other literatures, especially entrepreneurship theory of innovation argues that organizational routines developed with firm’s age constraint firm’s flexibility in absorbing and generating knowledge in dynamic market conditions. As a result, younger and smaller firms are able to recognize opportunities faster and respond to external change quicker. The transfer of knowledge spillover is regarded to be more efficient in younger firms than in older ones. Results of empirical tests are not consistent as well. Even in one research study, the effect of firm’s size or age changes depending on the indicators of innovation. For example, Knoben (2009) finds that firm’s size is significantly positively related to innovativeness in terms of products new to the firm or to the market while it has no relationship with innovativeness in terms of improved products. However, no significant relationship between age and firm’s innovativeness is found no matter which indicator is chosen. In addition, R&D input is generally accepted as key driver of innovation. Some literatures think that firm’s or nation’s R&D investment represents its innovative capacity and explains its economic heterogeneity or disparities. There is also no consensus in the role of R&D expenditure. For example, study from Crescenzi et al. (2012) finds that R&D spending in China has no significant relationship to local innovation in terms of local patenting activities. In this essay, we postulate that firm’s past experience in innovation might be able to explain firm-level innovativeness in some degree.

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Teece (1996)’s dynamic capabilities concept views technological development as path dependent. That is to say, related knowledge in previous innovative activity endows firm with ability in recognizing useful knowledge (Harris, 2011). Similarly, competence view of the firm stresses the importance of path-dependent knowledge for firm’s seeking and grasping opportunities within uncertain contexts (Foss, 1998; Raspe & Van Oort, 2008). Furthermore, international business literature has found evidence that exporting is a channel for knowledge spillover and that firms engage in international trade benefit from “learning by exporting” (Liu & Buck, 2007; Salomon & Jin, 2008). On one hand, firms with customer or supplier linkage in foreign market can obtain technological assistance from its partners and thus have more chance to become innovative. On the other hand, firms especially those from developing countries faces more competition when exposing to foreign market and then have more motivation and pressure to increase innovative productivity. A number of studies have provided evidence about the knowledge spillover from exporting. Additionally, one distinctive feature of Chinese economy is ownership diversity. There are state-owned enterprises, collectively-owned enterprises, Hong Kong, Macau and Taiwan owned (HMT) enterprises, family- or insider-owned and foreign-owned firms. Theoretically, firms with foreign ownership have more access to technological resources and other tangible resources. However, the branch-plant effect undermines the advantages (Love et al., 2009). Also, state-owned firms have political ties which might bring them institutional benefits while other firms have not. Empirical evidence in Chinese economy is very limited. Most of them appear to suggest a superior advantage of non-state ownership than state ownership. Choi et al. (2011) find that Chinese firm’s innovation performance is most strongly influenced by foreign ownership compared with other ownership types. Study from Li et al. (2014) shows that both state-owned and foreign enterprises advance regional innovation performance in Chinese provinces. However, foreign enterprises achieve higher-quality innovation.

We use four variables to capture the inter-industry difference. Industry size has been recognized as an important influential factor of innovation since Schumpeter. On one hand, greater market size implies greater profitability and thus induces more new entry. Increased market competition encourages firms to innovate especially in high-tech industries. Acemoglu & Linn (2004) develops a model linking innovation to potential market size and finds a positive effect of market size on entry of new drugs in U.S.

pharmaceutical industry. On the other hand, greater market size indicates immense industry networks and business associations which promote firms’ interaction and cooperation for innovative purpose. Similarly to firm-level R&D input, sector-level R&D input might contribute to industry knowledge capacity. In addition, market structure representing population density of one industry is often discussed because of its impact on innovation performance of the firms operating within the industry. Market structure comprises several competitive forces such as threat of entry, threat of substitute products, and rivalry amongst existing firms (Pecotich et al., 1999). Competitive market structure or industry dynamism requires firm’s higher organizational learning capabilities and innovation strategy and thus results in more rapid technological change (Utterback and Suarez, 1993; Weerawardenaa et al., 2006). A study by Hashmi and Bieseroeck (2016) about worldwide automobile industry finds that innovation is declining with the number of firms and the innovation gap between the leader and other firms increases with competition. Besides the above mentioned three variables, this essay focuses on the effect from foreign competition. Few studies have examined the relationship between foreign competition and innovation (Liu et al.; 2014). Even the evidence about the relationship between competition and innovation is ambiguous (Baldwin & Scott, 1987; Tang, 2006). The reality that firms in emerging market are facing more competition from foreign rivals encourages us to discuss the impact from foreign competition on firm’s innovation capability. Several empirical examples are available. Li and Vanhaverbeke (2009) investigate Canadian innovation and a U-shaped relationship between foreign competition and innovation. Liu et al. (2014) use a panel data of Chinese high-technology industries and find impact of foreign competition on innovation activities. As above figure presents, industries are able to provide industry knowledge which through competition knowledge spillover or technological knowledge spillover flows to firm.

On regional level, four variables are used to account for local knowledge capacity. Regional market size is generally regarded to be proportionally to R&D stock, especially when region dominated by firms operating in technology-intensive activities. Material or immaterial public R&D input is widely accepted as a factor influencing a region’s knowledge stock. The material input take the form of granted, tax credits or recruitment aids etc. Immaterial input is from public academic and research institutes. The knowledge influence from public institutes can be realized through several

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channels (Varga, 2000). One is the information diffusion via personal networks or employment activities in the form of well-educated students. The second one is the technology transfer between academic institutes and industries. The third one is spillover promoted by physical research facilities such as liabilities and scientific laboratories. Although many literatures have studied the efficiency of public R&D policies, their results are not consistent. Regional industry structure in the form of specialization or diversification is also essential for regional knowledge spillover. Literatures show that type and composition of local economic activities might affect firm’s technological progress. Debate about how the extent of specialization or diversification fosters MAR or Jacobs spillover has never stopped. For example, Li and others (2014) rely on panel data in Chinese provinces and find that regional innovation systems in China benefit more from Jacobs externalities than MAR externalities. However, there are very few empirical examples studying the relationship between regional industry structure and firm-level innovativeness. In addition, economic geography and other related knowledge literatures consider foreign direct investment (FDI) might be generator of knowledge spillover. Study from Van Pottelsberghe and Lichtenberg (2001) concludes that FDI transfers knowledge only in one direction: outward FDI can increase host country’s productivity while inward FDI cannot. In contrast, Bitzer and Kerekes (2008) find new evidence that inward FDI benefit strongly receiving countries and no evidence for positive outward FDI effect. We might think that, local firms in China as developing country can benefit from FDI-related technology transfer from technology-advanced to not-advanced countries or areas. However, study from Hu et al. (2005) indicates that FDI doesn’t facilitate the technology transfer across border. Result from Wang et al. (2016) illustrates that the effct of FDI on regional innovation is diminished by a specialized industrial structure. Above figure (Figure 3. 2) shows that knowledge resulting from these regional variables flows to firm through different mechanisms, such as geographical knowledge spillover (MAR spillover or Jacobs spillover), academic knowledge spillover, or foreign knowledge spillover.