Worker reallocation, firm innovation, and Chinese import competition

While recent work has documented a nexus between international trade and firm innovation, the underlying mechanisms explaining firms’ innovation in response to import competition are, thus far, poorly understood. To identify the mechanism of labor adjustments and its economic relevance, we use longitudinal linked employer–employee data from Denmark (1995–2012). We first show that import competition triggers a significant increase in the share of R&D workers at the firm level. The majority of the increase in the share of R&D workers is explained by between-firm, not within-firm, worker reallocation. The significance of this reallocation becomes evident when we show that innovation improvements are observed only among firms that experience a large increase in the share of R&D workers, especially if this increase is achieved through between-firm worker reallocation. We then extend our analysis to Portugal where the labor market is more rigid and find contrasting yet consistent results: labor reallocation occurs only within firms and it does not result in increased innovation.