Unlocking Innovation: The Impact of Free Trade Zones on Corporate Innovation in China

If the domestic market operates under an inefficient economic structure, then access to foreign markets can lead to long-term benefits. In this paper, we examine the effect of free trade zones (FTZs), a progressive trade liberalization program, on corporate innovation. By using data on Chinese publicly listed firms, we find that firms operating in FTZs experience significant increases in their innovation output. These positive effects are primarily attributed to the easing of financial constraints, increased market competition, and improved access to foreign markets, even though their effects on the quantity and quality of corporate innovation can be noticeably distinct. Our empirical findings are rationalized by a simple Schumpeterian model with endogenous quality improvement, and they provide implications for policymakers to promote domestic firm growth in the global marketplace.