Labor-induced Technical Change: Evidence from Doing Business in China

We examine the impact of a change in the relative price of labor on direction of technical change. We use a novel measure of technological progress, decom-posing innovation into products (new goods) and processes (lower production costs). We use the 1999 US-China bilateral agreement which increased the surplus extracted by US stakeholders vis-à-vis the Chinese stakeholders, effec-tively lowering the price of labor. We show that US firms with presence in China prior to the agreement respond by changing their composition of inno-vations as compared to firms without such presence – we find a reduction by 3 % in the share of process innovation. This result is driven by lower process innovations – they decrease by 19 % following the agreement – while product innovations do not change. We interpret this evidence to suggest that cheaper Chinese labor substitutes labor saving technological innovation. We are able to replicate the same pattern in a different setting, using inter-temporal variation of foreign investment restrictions across industries over the 1995-2012 period