The Impact of Emerging Market Competition on Innovation and Business Strategy

How do firms in high-income countries adjust to increased competition from low-income economies? Using large increases in import volume from China from 1999 to 2006 we estimate how a representative panel of Canadian firms adjusts their innovation activities, business strategies, and how this shock affects firm selection. We find that exit rates increase, domestic market shares and process innovations decline, consistent with standard models of endogenous innovation. Moreover, product innovation is systematically less affected than process innovation. Firms choose several margins to mitigate the adverse impact of increased competition. For example, larger firms and firms that are less focused on low-cost strategies or that focus on local niche markets are more insulated from low-wage competition. In particular, small firms' failure rates dramatically increase, while surviving small firms shift away from low-cost business strategies. Innovation-intense firms exhibit both higher failures rates and higher market shares conditional on survival, consistent with the view that innovation becomes more risky. Finally, firms focusing on local markets loose less domestic market share than large exporters, consistent with local niche products being more insulated from low-wage competition.