Does Offshoring Production Reduce Innovation: Firm-Level Evidence from Taiwan

Does the offshoring of production degrade or enhance the innovative capabilities of manufacturing firms? We contribute to this debate by exploiting a policy shock that differentially affected the ability of Taiwanese firms to offshore some products to China. We find causal evidence that offshoring impacts both the level and nature of innovation. In the technologies directly related to product categories that could be offshored more easily after the policy shock, overall innovation levels decline and innovative effort shifts away from product innovation and towards process innovation. However, we also find evidence of a second-order positive effect of offshoring on the levels of innovation—particularly product innovation—in other parts of the firm’s portfolio. These results are consistent with the notion that offshoring production induces a complex reallocation of innovation effort within the firm, both across and within technology categories. Our paper examines this reallocation in the context of Taiwanese electronics firms, and introduces new methods that could be used to study post-offshoring reallocations of innovative effort in other contexts. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.