Foreign Technology Dependence, Competition Pressure and Firm‐Level Innovation Mode Choice: Theory and Evidence From China

ABSTRACT In this paper, we first establish a series of stylized facts to demonstrate that collaborative innovation, in which firms diversify their R&D activities by outsourcing R&D activities to other research institutes/universities or importing foreign technologies, exhibits better innovation performance than self‐innovation. When facing more intensified foreign competition, only firms whose R&D capacity belongs to the upper‐middle percentiles diversify their R&D activities, whereas other firms' innovation diversification remains unaffected. We next develop a theoretical model to explain the empirical findings. The model incorporates the sequential choices of heterogeneous firms regarding innovation mode, R&D investment, and optimal markup under foreign competition. In equilibrium, a subset of firms switches from self‐innovation to diversified innovation to improve innovation performance and escape competition. After structurally estimating the model's parameters, we conduct a battery of counterfactual experiments, such as varying the degree of foreign‐technology dependence, to identify the optimal path for enhancing Chinese firms' innovation performance amid rising uncertainty in international markets.