Machines Could Not Compete with Chinese Labor: Evidence from U.S. Firms’ Innovation

We study how the change in the price of labor affects the direction of technological change using a novel measure decomposing innovations into products (new goods) and processes (lower production costs). Using the 1999 U.S.-China agreement as a shock that lowered effective labor cost, we find that U.S. firms operating in China decrease their share of process innovations by 9% and that this adjustment is driven by lower process innovation. We obtain the same results using a staggered loosening of restrictions on foreign ownership across industries in China over 1995-2012. This suggests that cheap abundant labor substitutes for labor-saving innovation.