A Structural Model of Indigenous Innovation and Catch-Up for Developing Economies

Abstract

This paper introduces an extended structural innovation model a la Crepon et al. (1998), adapted to study empirically the process of indigenous innovation and catch-up in a developing economy context. Specifically, three key extensions to the original model are introduced in order to study how FDI, spillovers and policy reforms, respectively, drive innovation and what are the implications for productivity. Using a large panel of firms in China, the results reveal that receiving more FDI boosts Chinese firms’ innovation and productivity driven by their attempts to adapt foreign technologies to local applications. Moreover, FDI liberalization policies are more successful in regions with higher local industrial relatedness, indicating the importance of combining opening-up reforms with regional clustering policies to spur the indigenous innovation process and promote catch-up. Beyond the empirical findings, a key advantage of the extended structural model is that it can be readily extended to other developing economies.