Using Chinese firm-level manufacturing production data during the period 1998-2007, we first estimate the firm-level distortion in intermediate input markets and then identify the effects of distortion on firm innovation. The results show that: 1) The distortion in the intermediate market significantly reduces the level of firm innovation, and these negative impacts are stronger in state-owned enterprises, industries with greater financing constraints, and firms in the western region. 2) The mechanism study shows that the distortion in intermediate goods market mainly affects firm innovation through three ways: increasing firm rent-seeking behavior, reducing capital intensity, and restricting the improvement of production efficiency.
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