Openness, Absorptive Capacity and Regional Innovation in China
Chih-Hai Yang∗
Department of Economics
National Central University
E-mail: chyang@mgt.ncu.edu.tw
Hui-Lin Lin
Department of Economics
National Taiwan University
E-mail: huilin@ntu.edu.tw
Abstract
This paper systematically investigates the impacts of openness on regional innovations in
China, especially the role of absorptive capacity in mediating the spillover effect brought
about by openness. Based on provincial-level data over the 1997-2007 period, the empirical
results show that the estimated patents-R&D elasticity is lower than that for OECD countries,
while there is a significant R&D spillover effect across regions in China. The innovation
effect of technology imports is negative, suggesting that it may serve as a substitute for
in-house R&D and thereby result in a negative influence on innovation. Openness to trade, in
terms of FDI and high-tech product exports, is witnessed to exhibit a significantly positive
impact on the promotion of regional innovation. Importantly, the effects of technology
imports and FDI on innovations vary significantly between coastal and non-coastal regions.
Using human capital as a proxy for absorptive capacity, we find that it helps to learn external
sources of knowledge and then contributes to innovation. Moreover, absorptive capacity is
expected to play an important role in mediating the spillover effect brought about by
openness to trade.
JEL codes: O32, O34
Key words: R&D, Technology Import, Patent, Absorptive Capacity
∗ Corresponding author: Department of Economics, National Central University. 300, Jhongda Road, Jhongli City
320, Taiwan. Tel: +886-3-4227151 ext 66318. E-mail: chyang@mgt.ncu.edu.tw
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1. Introduction
The endogenous growth theories, e.g., Grossman and Helpman (1991) and Aghion and
Howitt (1992), have modeled innovation as a key driving force of sustainable economic
growth and this viewpoint is widely supported in the existing empirical literature.1 Since the
implementation of its open-door policy in the late 1970s, China has experienced a long period
of extraordinary growth, relying mainly on factor accumulations. Recognizing both that there
is nothing miraculous about rapid growth by factor accumulation and the importance of
innovations to growth, the Chinese government as well as the private sector have since the
mid-1990s gradually begun to devote more efforts to innovative activities, aiming to achieve
a sustainable growth, promote indigenous technological capability, and meet the needs of
industrial transformation (Hutschenreiter and Zhang, 2007). In actual fact, China’s R&D
expenditure has increased nearly eleven times - from RMB 40.448 billion in 1996 to RMB
440.004 billion in 2008. Correspondingly, the number of patents granted to domestic
inventors has rapidly expanded from 39,725 to 352,406. In addition, the R&D/GDP ratio, a
simple measure of a knowledge-intensive economy, has also climbed quickly from 0.57% in
1996 to 1.50% in 2008.2 Despite this figure being quite low by OECD standards, it is much
higher than in other developing countries with similar or higher per capita GDP, e.g., Brazil,
Malaysia, and Thailand.3
However, one serious problem that arises along with the development strategy of an
open-door policy that favors coastal regions is that technological advancements give rise to a
The efforts devoted to promoting scientific and technological
development have been verified to have significantly contributed to regional economic
growth in China over the past decade (Kuo and Yang, 2008).
1 See Acemoglu et al. (2006) for a comprehensive survey of the interaction among the degree of economic
development, R&D, and economic growth.
2 Observing this increasing trend in R&D intensity, Gao and Jefferson (2007) examine whether China has begun
a similar S&T take-off. The authors review several conditions identified in the endogenous growth literature that
drive R&D intensification and note their emergence in China during the past decade. They also speculate why
China’s R&D intensification appears to be starting at such a low level of income per capita.
3 For instance, the R&D/GDP ratio of Thailand and Malaysia reached only 0.26% in 2003 and 0.69% in 2002,
respectively.
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divergence in development between the coastal and inner regions in China. Figure 1 presents
the rankings and scores of Chinese regional innovative capability in 2006.4 While the
magnitude of a score is not a perfect index of innovative capability, it does indicate that the
highest ranking received a score of 57.09 that was nearly four times that of the lowest ranking
(14.3), suggesting that the regional technological capability is divergent across provinces.
More importantly, the distribution of the rankings varies geographically in that most of the
top rankings are concentrated in the coastal regions. In terms of the top ten rankings, only two
provinces/municipalities, Chongqing and Shaanxi, are located in inland regions, while the
remainder are coastal provinces, there being only 12 provinces located in the coastal regions.5
[Insert Figure 1 approximately here]
As Figure 1 indicates, China’s regional innovation capability is quite divergent, and in
particular, the coastal provinces seem to outperform their non-coastal counterparts in terms of
innovative capability.
The widening divergence in regional innovative capability has recently attracted the
attention of many scholars who have sought to discuss the potential causes from the
viewpoint of a regional innovation system (RIS), e.g., Liu and White (2001) and Sigurdson
(2004). As China’s post-reform economic development has mainly relied on export-led
growth that has opened coastal regions to attract foreign direct investment (FDI) to establish
production affiliates that have then exported their products to the global market, openness to
trade and its consequential spillover effect may alternatively play a critical role in promoting
regional innovation. Furthermore, relative to in-house R&D, technology imports serve as an
alternative source of technology for open developing countries (Katrak, 1997). While they
offer immediate access to desirable technology, they usually come with certain restrictions
4 The scores are obtained from the Chinese Regional Innovative Capability Evaluation Report that is published
by the Ministry of Science and Technology of China. In this report, a region’s innovative capability is measured by
five indicators, including technology creation, technology acquired, enterprise innovation, innovative environment,
and innovative benefit. The weights for each indicator are 0.15, 0.15, 0.25, 0.25, and 0.2, respectively.
5 In Shaanxi Province, R&D expenditure is composed of mainly government expenditure that is devoted to space
and artificial satellite technologies.
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and could eventually lead to technological reliance. Therefore, technology imports may either
substitute or complement domestic R&D and then induce an indirect influence on innovation,
depending on the host countries’ capacity to absorb and apply knowledge embodied in
imported technologies. It provides the inspiration for the main purpose of this study which is
how and to what extent openness to trade and foreign technologies contribute to regional
innovation in China.
Whether intra- or/and inter-regional spillovers are effective heavily depends on the host
region’s absorptive capacity. That is, absorptive capacity is a prerequisite for the possible
spillover effect on regional innovations brought about by openness. Borensztein et al. (1998)
utilized human capital accumulation as a measure of absorptive ability and first confirmed the
importance of the host country’s absorptive capacity in learning technology spillovers from
foreign firms. The knowledge-capital model of multinational enterprises developed by Carr et
al. (2001) also emphasized that the abundance of skilled labor in the host country can affect
the international flow of knowledge through FDI. In addition to human capital, R&D can also
improve the technological capability as well as learning from external sources of knowledge,
and these two are referred to as “the two faces of R&D” (Griffith et al. 2003). In other words,
when a region attempts to imitate advanced technologies from domestic and/or foreign
sources, the extent of the learning effect crucially depends on the region’s own absorptive
ability.
This paper aims to understand the driving force behind regional innovation in China,
bearing in mind the manifest geographical concentration of innovation in China. By utilizing
provincial-level panel data over the 1997-2007 period to perform the estimations, this study
attempts to contribute to the literature by providing the following distinct types of empirical
evidence. First, besides the key input of knowledge production, in-house R&D, acquiring
advanced technologies directly from abroad is also an important channel for developing
countries to accumulate knowledge capital. How, then, do technology imports affect domestic
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innovation in China? Do they serve as a substitute for domestic R&D and thereby reduce
innovation, or can they be revised to meet local needs and spur further innovation? This issue
is especially important to China’s technology policy, but there is so far little empirical
evidence. Secondly, and most importantly, how and to what extent does openness in terms of
various channels affect regional innovation? FDI and learning-by-exporting have for long
been regarded as important channels for developing countries to learn and absorb foreign
advanced knowledge, contributing to the promotion of technological capability. The
increasing divergence in innovative capability between coastal and non-coastal regions may
be attributed to various degrees of openness and this conjecture will be developed and
examined in this study. Third, while the aforementioned FDI and trade may impact China’s
regional innovation through knowledge spillovers, its effect hinges on the absorptive capacity
of the host region. This study will assess the indirect effect of this absorptive ability on
learning foreign knowledge. Furthermore, whether the key source of regional technology,
R&D, may spill over to neighboring provinces will also be examined, with a view to testing
the existence of cross-regional knowledge spillovers in spurring innovation.
The remainder of this paper is organized as follows. Section 2 briefly summarizes the
discussion on the effects of openness and absorptive capacity on innovation and reviews the
literature on the determinants of regional innovation in China. Section 3 depicts the
innovative activity, FDI and exports in China. Section 4 presents the empirical model to
investigate the effects of openness and absorptive capacity on regional innovation. The data
utilized in this study are also introduced. Section 5 reports and discusses the empirical results.
Concluding remarks and policy implications are summarized in the final section.
2. Openness, Absorptive Capacity, and Innovations
2.1 Openness and external sources of technologies
For developing countries, technological capability can be developed internally and/or
acquired externally. Internal technological sources are mainly in-house R&D activities, while
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external sources include either technology imports obtained directly from foreign firms or
technology transfer from the local affiliates of foreign companies engaging in foreign direct
investment (FDI). While in-house R&D activities can lead to the acquisition of proprietary
technologies, they are risky and time-consuming. To be specific, it is hard for developing
countries to compete with technology-frontier countries in the international patent race due to
their limited technological capability. Therefore, external sources play a critical role in
promoting technological capability and stimulating innovation in developing countries.
Among the external sources, acquiring advanced technologies directly from abroad is the
most important channel for developing countries to accumulate knowledge capital (Katrak,
1997).6
6 It offers immediate access to desirable technology, but it usually comes with certain restrictions and may
eventually end up with technological reliance.
Griffith et al. (2003) make an important contribution in this line of research by
developing a microeconomic foundation (industry-level) for the reduced-form equations of
productivity growth. It incorporates technology transfer as a key source for non-technological
frontier countries, thus highlighting the importance of technology imports in raising
technological capability. However, how technology imports impact innovations depends on
the relationship between R&D and technology imports and the host country’s capacity to
absorb imported technologies. If the host country’s technological capability is quite low, it
may become a serious barrier to fulfilling the potential of these technologies. Thus, the
acquisition of external technology may directly serve as a substitute for domestic R&D
leading to a reduction in further innovation. Alternatively, technology imports are probably
complementary to in-house R&D, because the host country can revise imported technologies
to meet the needs of local markets. Through learning from and adapting advanced
technologies, local firms are able to further develop new patenting technologies and induce
adaptive innovations. A limited number of studies, such as Ray and Bhaduri (2001) and Yang
and Chen (2001) have lent support to the view that technology imports serve as an important
driving force in enhancing technology build-up and innovations.
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In regard to openness, the inflow of FDI into the economy is widely considered to be one
of the main sources of economic and technological growth. Besides the contribution of
capital inflows, the advanced technologies and knowledge used by multinational enterprises
(MNEs) can spill over to local firms and promote their technological capability through a
variety of channels. Blomström and Kokko (1998) summarize the possible channels as
follows. First, local firms can imitate technologies used by MNEs and then improve their
technological capability. Second, as former MNE employees take up employment in other
domestic firms, they may take with them explicit technologies and tacit knowledge which
may be applied in the domestic firms and then contributed to promote technological
capability. Third, the so-called demonstration effect is that MNEs create positive forward and
backward linkage effects by providing similar services to local purchasers and technological
information to help the relevant local networks. The positive effect has been witnessed in
many developing countries, e.g., Mexico (Blomström, 1986), Indonesia (Sjöholm, 1999), and
Lithuania (Javorick, 2004).7
The industry development model of OEM (original equipment manufacturing) prevails
among East Asian emerging economies, including China. By embracing the globalization of
production through the advantages of cheaper endowments and increased foreign direct
investment (FDI), China has become the so-called “World’s Factory” in international markets
for a variety of information and communications technology (ICT) goods since the early
2000s. Exporters can often access diverse knowledge inputs that are unavailable in the
domestic market so that this knowledge can spill back to the local firms, and that such
learning can foster increased innovation (Salomon and Shaver, 2005). Competition and
exposure to a superior foreign market can also speed up technological acquisition and thus
lead to the promotion of technological capability as the host exporting country’s technological
capability reaches a certain level. It is the so-called “learning-by-exporting” effect (Clerides et
7 On the other hand, the presence of MNEs sharply reduces the local firms’ market share in the domestic market,
causing local firms to be unable to reduce their average cost and resulting in lower productivity.
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al., 1998). Some studies examining the relationship between exporting and innovation have
supported this positive nexus in developing countries, e.g., Brazil (Braga and Willmore, 1991)
and Malaysia (Lee, 2004).
2.2 Absorptive Capacity, Regional Spillover and Technological Progress
Although the various channels of openness may positively influence innovations through
spillover to local firms, the role of a host region’s absorptive ability as a means of learning
foreign technology has recently attracted attention. Borensztein et al. (1998) first consider the
effect of absorptive capacity in terms of absorbing technologies embodied in FDI and find
that the incidence of technology spillovers via FDI hinges on the level of human capital.
Kinoshita (2000) employs R&D expenditure as a proxy for absorptive ability in a study of
Czech manufacturing firms. Their results indicate that the degree of spillover from FDI is
positively associated with the host country’s R&D expenditure. Griffith et al. (2004) also
include R&D as a proxy to investigate the role of absorptive ability in productivity growth.
Their OECD industries find evidence of R&D being statistically and economically important
both in technological catch-up and innovation.
Moreover, the effect of regional R&D spillovers on economic growth and innovation are
widely discussed in both the theoretical and empirical literature. Krugman (1998) argues that
the marginal cost of transmitting tacit information across regions increases with distance
because non-codified knowledge is vague and requires face-to-face interactions. Thus, R&D
spillovers may face geographical boundaries. Kelly and Hagemann (1999) establish a quality
ladder model of growth to allow Marshallian externalities in innovation. By assuming that the
Marshallian externality is more important for innovation than for production and innovation
and that production need not occur in the same region, their model argues that R&D activities
can have an important effect on growth irrespective of the region. This effect of spatial R&D
spillovers has recently been widely examined by using European regions, e.g., (Lόpez-Bazo
et al., 2004; Funke and Niebuhr, 2005; Cabrer-Borras and Serrano-Domingo, 2007).
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2.3 Literature review
Compared to the research on the increasing R&D intensity and widening disparities in
technological capability across regions in China, the determinants of regional technological
advancement in the form of patenting have not been systematically examined in depth. Two
lines of empirical studies have recently been conducted to examine the R&D-patent nexus.
One has used provincial-level data and the other has adopted micro data that has benefited
from the recent accessibility to firm survey data.
In terms of provincial-level studies, Sun (2002) investigates the effects of R&D and
technology imports on the innovative behavior of large and medium-sized manufacturing
enterprises. Based on cross-sectional data for the year 1999, they find that in-house R&D,
rather than imported technologies, is the primary source of industrial innovation. However,
this study cannot captu