The Impact of Emerging Market Competition on Innovation and Business Strategy: Evidence from Canada

Does intensifying emerging market competition boost or inhibit innovation? We estimate how a representative panel of Canadian firms adjusts innovation activities, business strategies, and exit in response to large increases in Chinese import competition. Our analysis shows that the innovation response of firms depends on the type of innovation: on average, product innovation incentives are stimulated by competition while process innovation incentives decline. We develop a theory that combines these different innovation types with partially irreversible innovation strategy choices to derive novel performance implications in response to competition. Consistent with this theory, we find that firms that initially pursue process innovation strategies and survive have higher profits ex-post, but are ex-ante more likely to exit. In contrast, firms that initially pursue product innovation strategies have higher profits if they survive, without significant impact on exit. Both empirical patterns are consistent with our theory, which suggests that innovator performance depends on the balance of innovation incentive effects and competitive failure risk.