Decentralization and firm innovation: Evidence from a natural experiment in China

Abstract

This paper examines the impact of decentralization on firm innovations based on a unique setting in China, the delegation of approval authority for export tax rebate in 2006. Using difference-in-differences approach, we find that 1) export enterprises generate more patents, after the municipal taxation bureaus delegated the authority of export tax rebate approval to lower governments. 2) Placebo tests by falsifying the pilot time and cities establish the causality. 3) The effect is particularly more pronounced for export enterprises with higher financial constraints, higher information asymmetry and weaker relationship with local governments. Overall, this study provides new insight about the real effect of the decentralization of government activities on firm innovations, which may be of interest to regulators who are concerned with the authority delegation and simplification of administrative procedures.