Machines Could Not Compete with Chinese Labor: Evidence from U.S. firms’ innovation

We study how multinational firms’ access to offshore labor affects their decisions to develop new production technologies. The 1999 U.S.–China bilateral agreement improved contracting institutions in China, reducing uncertainty for U.S. multinationals and enabling cheaper labor sourcing through FDI. Using data from U.S. parent companies and their Chinese subsidiaries, we show that U.S. firms expanded their Chinese operations and increased subsidiaries’ profitability post-agreement. Our novel measure reveals that U.S. multinationals reduced process innovations after the agreement. These findings highlight the impact of cross-border labor sourcing on domestic technological development, highlighting that production and technological choices of multinationals are jointly determined.