The impact of financial constraints on firm R&D investments: empirical evidence from China

Innovation is essential for economic development and critical for firms to remain competitive. However, Chinese firms lag behind developed economies in terms of innovation, as measured by investments in R&D. R&D investments are more likely to be subject to financial constraints than ordinary investments as a result of higher risk and longer gestation periods. Using a unique World Bank survey of 12,400 manufacturing firms in China, this paper investigates the effects of financial constraints on firm R&D activities. We find that the access to a bank line of credit is positively and statistically significantly associated with firm R&D. We further use an exogenous shock of credit crunch caused by macroeconomic control policies in 2003-2004 to identify the effects of financial constraints on R&D. We find robust evidence that firms adversely shocked by the credit crunch reduced or even ceased R&D investments. Our findings highlight how financial constraints in fact reduce R&D investment in countries.