We study how an improvement in contracting institutions due to the 1999 U.S.-China bilateral agreement affects U.S. firms’ innovation. We show that U.S. firms operating in China decrease their process innovations—innovations that improve firms’ own production methods—following the agreement. We obtain the same result using the inter-temporal variation in ownership restrictions on foreign investment in China across industries. These findings suggest that a better ability to source labor cheaply across borders affects the types of technologies that are being developed less process innovation aimed at reducing production cost. More broadly, a decrease in the effective price of labor due to the removal of frictions affects corporate innovation.
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