Innovation and International Competition: Evidence from Mexico∗ PRELIMINARY AND INCOMPLETE, PLEASE DO NOT CITE WITHOUT PERMISSION

How does trade liberalization that raises a country’s import competition affect the innovative activity of its firms? We exploit the strong growth of Chinese exports resulting from China’s entry into the World Trade Organization in 2001 as a competitive shock to, specifically, Mexican manufacturing firms. Innovation is captured through information on the adoption of detailed firm level production techniques such as just in time inventory methods, quality control measures, and job rotation among the Mexican firms. Our results indicate that China’s rise in global trade did not affect by much Mexico’s rate of innovation, which contrasts with the substantial gains that others have found in the case of bilateral liberalizations. At the same time, there is a striking heterogeneity in the responses across firms for different labor productivities, with productive firms innovating more and less productive firms innovating less, which leads to positive selection in that initial differences in firm performance are sharpened by the advent of new competition. We discuss the implications of these findings for theories of trade and innovation. ∗The authors are grateful to, ... The financial support of the World Bank’s Research Support Budget is gratefully acknowledged. †Development Research Group, World Bank, 1818 H Street, NW; Washington, DC, 20433, USA. Email: [email protected] (Corresponding author). ‡University of Colorado, PO Box 256, [email protected] §The University of Vienna, Hohenstauffengasse 9, A-1010 Austria. Email: [email protected]