The Impact of the Trade War: Divergence in Chinese and U.S. Innovations in the Post-Conflict Era

Abstract: This paper examines the impact of the US-China trade war on China’s innovation intensity and direction. Employing a textual analysis method to measure the direction of Chinese firms’ innovation compared to that in the US by assessing the similarity between the text of Chinese and US patents, this study finds that increased exposure to US export tariffs reduces the similarity, especially with recent US patents. China’s innovation similarity with other developed countries also declines, though to varying extents. Additionally, export tariffs are shown to decrease patent filings in China. To explain these effects, we incorporate the textual analysis algorithm into a quantitative economic model where firms endogenously choose their innovation efforts in various directions within each product. Quantification analysis shows that the demand channel accounts for 48% of the decline in China-US innovation similarity due to tariff shocks. Innovation intensity and direction choices contribute to a 6% decline in Chinese firms’ export sales, with direction alone accounting for 1.68%.