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Empirical Economics
Published in: Empirical Economics 1/2023

01-12-2022

Induced innovation and its impact on productivity growth in China: a latent variable approach

Authors: Ka Kei Gary Wong, Min Qiang Zhao

Published in: Empirical Economics | Issue 1/2023

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Abstract

This paper proposes a latent variable approach to examine the induced innovation hypothesis originating from Hicks (The theory of wages, Macmillan, London, 1932). It allows a flexible decomposition of total factor productivity into Type I (exogenous) and Type II (induced) technical changes using a latent variable d as an argument in a variable cost function. By making extensive use of duality theory, we are able to estimate the Hicksian input demand functions, which are explicit in d but may lack a closed-form representation in terms of observable variables such as input prices and output level. The “unobservability” of d is solved by using a numerical inversion estimation method. We apply this methodology with an appropriate estimator to investigate the impact of induced innovation on China’s total factor productivity growth. Our findings indicate that the induced innovation hypothesis is strongly supported by the data and that induced innovation has a positive and profound effect on China’s productivity growth.
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Appendix
Available only for authorised users
Footnotes
1
This conclusion is in line with the Habakkuk (1962) hypothesis and Allen’s (2009) argument about the connection between high wages and the British industrial revolution.
 
2
Wei, Xie and Zhang (2017) estimated that the growth of TFP has been persistently negative and large since 2009.
 
3
There are only a few papers that examine the connection between factor scarcity (rising factor prices) and induced innovation in China, such as Fleisher et al. (2021) and Wong et al. (2022).
 
4
Another way to model the impact of IIE on Cd is to incorporate a technological externality in the variable cost function as suggested by Romer (1986) and Acemoglu (2010).
 
5
In Fleisher et al. (2021), over-restrictive functional forms such as Cobb–Douglas and log forms were adopted to represent the production function of the final good and the cost function of generating d, respectively, in order to measure explicitly the impact of induced innovation.
 
6
The quadratic trend (t2) could be included to improve the flexibility of the model. Preliminary results however indicate the incorporation of t2 in GAi is not statistically significant based on the Wald test result.
 
7
The restrictions in Cases 1 to 3 will be tested by the standard Wald test.
 
8
Since the mixed cost share system (18a) and (18b) is static, it could be estimated using panel data with an appropriate estimator.
 
9
Notice that the crude oil prices for years before 1998 are obtained from the 2016 Daqing Statistical Yearbook, which provided the benchmark price set by the Daqing oil field. From 1998 onward, the Chinese government relaxed price controls by implementing a market-oriented reform of petroleum products, so we use the producer price index of crude oil, obtained from the NBSC (2020), to extend the price series of crude oil to 1998 and beyond. In regard to the coal price prior to 1996, it is collected from China Prices Press (1998), whereas we use the Bohai-Rim Steam-Coal Price Index, provided by Wu et al. (2016) and Qinhuangdao Coal Network (2020), to extend the series to 1996 and beyond.
 
10
The exchange rate data are obtained from the CEIC China premium database (2021), and the other data are downloaded from the website of the World Bank (2021).
 
11
The Wald test was done with the help of the ANALYZ procedure in the TSP computer package.
 
12
It should be noted that the elasticity estimates reported here are not directly comparable with those obtained by Wong et al. (2022). In our model, we have two types of capital inputs, and output level rather than output price is treated as exogenous.
 
13
The derivation of the decomposition Eq. (30) is provided in Appendix 1. Our decomposition approach is similar to the one proposed by Karagiannis and Mergos (2000), wherein they use a profit function to represent technologies and decompose productivity growth.
 
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Metadata
Title
Induced innovation and its impact on productivity growth in China: a latent variable approach
Authors
Ka Kei Gary Wong
Min Qiang Zhao
Publication date
01-12-2022
Publisher
Springer Berlin Heidelberg
Published in
Empirical Economics / Issue 1/2023
Print ISSN: 0377-7332
Electronic ISSN: 1435-8921
DOI
https://doi.org/10.1007/s00181-022-02333-2

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