Does firm innovation improve aggregate industry productivity? Evidence from Chinese manufacturing firms

This paper investigated to what extent firm innovation improves the aggregate productivity of the Chinese manufacturing industry in the presence of market distortions. By deriving a measure of firm-level distortions, we examined the role of market distortions in determining resource reallocations and aggregate productivity. The results indicate that firms become more productive and attract more resources through innovation, while market distortions also have large impacts on across-firm resource reallocations. Based on a productivity decomposition approach, we found that resource reallocation negatively contributes to aggregate productivity growth (APG) and that the contribution of firm innovation to APG is small. Our results suggest that firm innovation has not yet become the dominant factor in determining resource allocations and APG in China. In addition to boosting innovation, our study highlights the importance of improving the efficiency of resource allocation to improve aggregate industry productivity.