Agglomeration and product innovation in China

Hongyong Zhang 21 July 2014

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Spatial agglomeration of economic activities is generally assumed to improve productivity and spur firms’ innovation through localisation economies and urbanisation economies.1 There is an extensive empirical literature investigating the effects of localisation and urbanisation on firm-level productivity. Despite its economic importance, there are few empirical studies focusing on agglomeration and product innovation. Feldman and Audretsch (1999) and De Beule and Van Beveren (2010) are two of the few exceptions. Feldman and Audretsch found a tendency for innovative activity in complementary industries sharing a common science-base to cluster together in a city. In the US, diversity has a strong positive effect and specialisation has a negative effect on new product introductions. De Beule and Van Beveren (2010) found a positive impact of own-industry employment concentration on the product innovation of Belgian firms. However, they considered localisation only.

Does agglomeration account for product innovation in developing countries such as China? If it does, how do the innovation activities of Chinese firms benefit from agglomeration economies, from localisation economies, and/or from urbanisation economies? To address the above questions, in my latest paper (Zhang 2014) I empirically analysed the effect of agglomeration economies on firm-level product innovation using Chinese firm-level data from 1998 to 2007.2 Although the deepening of industrial agglomeration in China and its effect on productivity are well documented (see for example Lu and Tao 2009, Lin et al. 2011), whether agglomeration contributes to product innovation has not been explored.

Measures of agglomeration and product innovation

I followed Martin et al. (2011) to construct variables for agglomeration economies at the industry-city level.3 Localisation economies are measured by the number of other workers working for neighbouring firms in the same industry and in the same city. Urbanisation economies are measured by the number of workers in other industries in the same city and by the diversity of industries in the same city.

The criteria used by the National Bureau of Statistics for measuring the variable ‘new products’ are as follows: New products refer to brand new products produced with new technology and new design, or products that represent a noticeable improvement in terms of structure, material, or production process, significantly improving the character or function of the older versions. They include new products certified by relevant government agencies within the period of certification, as well as new products designed and produced by enterprises within a year without certification by government agencies.4

Geographical distribution of product innovation

Table 1 shows that there is wide variation across provinces regarding new product output, new product intensity, and the share of new product firms. The coastal provinces – especially Beijing, Tianjin, Shanghai, Jiangsu, Zhejiang, Shandong, and Guangdong – account for a large amount of new product output. Meanwhile, inland provinces, such as Inner Mongolia, Guizhou, Qinghai, and Ningxia have very limited new product output. In terms of new product intensity, compared with the average of all provinces (3.6%), Beijing (19.2%), Tianjin (10.5%), Sichuan (9.1%), Chongqing (8.3%), and Zhejiang (7.4) are the most innovative, whereas Hainan (0.4%), Inner Mongolia (0.5%), Tibet (0.8%), and Xinjiang (1.3%) are the least innovative. Furthermore, Beijing, Tianjin, Zhejiang, Chongqing, and Sichuan have the highest percentage of firms with new product introduction, at about 20%. On the other hand, Inner Mongolia, Fujian, and Hainan have the lowest percentage of such firms at 1.1%–2.9%. These findings suggest that there are large disparities in product innovation across regions in China.

Table 1. Product innovation across regions (2007)

 

Note: New product intensity is the ratio of new product output to total output.

Urbanisation economies, not localisation economies, contribute to product innovation in China

From the estimation of a model of new product introduction, I find that urbanisation economies – both size and diversity of neighbouring industries – make statistically significant contributions to the probability of new product introduction. Conversely, I find that there are no positive effects of localisation economies. Using an alternative measure of product innovation for the dependent variables, I find that the new product output and new product intensity are also benefits from urbanisation economies rather than localisation economies. All estimations are carried out after controlling for the local strength of competition and firm-specific characteristics, including total factor productivity (TFP), firm size, average wage, ownership, and production subsidy. So it is obvious that product innovation is determined not only by firms’ internal capacity, but also by external economies (urbanisation economies here).

In addition, I divide all of the samples into several sub-samples – domestic firms and foreign-invested firms, high-tech industries and other industries. The aim is to investigate whether there are differences in factors affecting product innovation by ownership or sector. Urbanisation, size, and diversity are still strongly positively associated with the probability of new product introduction and new product output. The results show that the contributions of urbanisation economies are stronger for domestic firms than for foreign-invested firms, and stronger in high-tech industries than in other industries.

Policy implications

Clusters with industrial diversity can be an effective means of fostering product innovation. Policymakers could promote product innovation by encouraging firms to locate in industrially diversified areas. Chinese authorities have established more than 100 economic zones (such as economic and technological development areas and high-technology industry development areas) in over 60 cities since 1995. Note that most of these economic zones – such as Zhongguancun Science Park (Beijing) and Suzhou Industrial Park (Jiangsu Province) – are not clusters of firms from the same narrowly defined industry (such as a 2-digit or 3-digit industry). The deepening of inter-industry outsourcing, knowledge spillovers, and procurement of intermediate goods are likely to lower the sunk costs of introducing new products, and thereby to promote product innovation.

Editor’s note: The main research on which this column is based (Zhang 2014) first appeared as a Discussion Paper of the Research Institute of Economy, Trade and Industry (RIETI) of Japan.

References

Brandt, L, J Van Biesebroeck and Y Zhang (2011), “Creative accounting or creative destruction? Firm-level productivity growth in Chinese manufacturing”, Journal of Development Economics, 97: 339–351.

De Beule, F and I Van Beveren (2010), “Does firm agglomeration drive product innovation and renewal?”, KU Leuven VIVES Discussion Paper 14.

Feldman, M P and D B Audretsch (1999), “Innovation in cities: Science-based diversity, specialization and localized competition”, European Economic Review, 43: 409–429.

Lin, H, H Li and C Yang (2011), “Agglomeration and productivity: Firm-level evidence from China’s textile industry”, China Economic Review, 22: 313–329.

Lu, J and Z Tao (2009), “Trends and determinants of China’s industrial agglomeration”, Journal of Urban Economics, 65: 167–180.

Martin, P, T Mayer and F Mayneris (2011), “Spatial concentration and plant-level productivity in France”, Journal of Urban Economics, 69: 182–195.

Zhang, Hongyong (2014), “How Does Agglomeration Promote the Product Innovation of Chinese Firms?”, RIETI Discussion Paper 14-E-022.

Footnotes

1 Localisation economies indicate that the concentration of an industry in a given area generates positive externalities on input markets, labour markets, or knowledge exchange. By contrast, urbanisation economies imply that industrial diversity in a city facilitates the transmission of technology and knowledge of different industries, thus creating new knowledge and technology.

2 The large dataset comes from the Annual Surveys of Industrial Firms conducted by China’s National Bureau of Statistics. The survey includes all industrial firms that are state-owned, or non-state owned firms with sales above five million RMB. See Brandt et al. (2011) for details.

3 I use the Chinese Industry Classification at the two-digit level. The number of cities is about 336 during the sample period.

4 According to Lu and Tao (2009), a product is identified as a new product by the National Bureau of Statistics only if it is produced for the first time at least within a province. As Lu and Tao (2009) point out, some of the new products may just reflect local catch-up efforts in copying new products from other firms located in other regions and, to some extent, a considerable percentage of innovation in China involves imitation. However, this still represents an important step forward in product development and product innovation.

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Topics:  Productivity and Innovation

Tags:  R&D, productivity, China, spatial concentration, innovation, subsidies, clusters, agglomeration

Fellow, RIETI; Lecturer at the School of Economics, Senshu University