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Can Investment Incentives Crowd Out Innovation? Evidence from China

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  • Shaowei Ke
  • Yao Lu
  • Xinzheng Shi
  • Yeqing Zhang

Abstract

We analyze the indirect effect of a fixed asset investment incentive on firm innovation by estimating the influence of China’s value-added tax reform in 2004 using a difference-in-difference-in-differences approach. We find that the fixed asset investment incentive significantly reduces firm innovation. In a simple model, we show that the reduction could arise because some firms choose to upgrade their technology as a result of the investment incentive and advanced technology crowds out innovation. Consistent with the predictions, we find that this negative effect is evident in firms with intermediate-level financial constraints but not in firms with tight or loose financial constraints. Moreover, firms with intermediate-level financial constraints increase their fixed asset investments and technology costs after the reform, while other firms do not.

Suggested Citation

  • Shaowei Ke & Yao Lu & Xinzheng Shi & Yeqing Zhang, 2025. "Can Investment Incentives Crowd Out Innovation? Evidence from China," Economic Development and Cultural Change, University of Chicago Press, vol. 73(3), pages 1023-1072.
    • Handle: RePEc:ucp:ecdecc:doi:10.1086/729622
    DOI: 10.1086/729622
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