Journal of Quantitative & Technological Economics, 2024, Issue 7

Authors: LV Yue, ZHANG Haotian, XIE Hongjun

Abstract: The large number of patents held by Chinese firms but their lack of quality has become amajor reason why firms are stuck at the lower ends of the global value chain. Why does this disparity exist? We provide an explanation based on the system where local governments in China invite businesses to invest by transferring land at low or even negative prices, This approach has created a hidden subsidy in the land transfer system, which changes the incentives for firms and leads them to act in ways that prioritize patent quantity over quality. We develop a theoretical model to show how this practice of transferring land to attract investment can lead to firms focusing on getting more patents rather than making them better in quality. Given the a symmetric patent information between local governments and firms, there is a tendency for firms toproduce a large number of lower-quality patents. Here's a simpler way to understand it: To meet the screening criteria made by local governments of land acquisition requests , firms invent a large number of patents with relatively low quality, in order to acquire the right to use industrial land at a low price, considering local governments’ preference for high-tech firms but almost no capability to distinguish high-quality patents. This is called the strategic innovation behavior. Furthermore, after acquiring the land, firms continued its previous strategic innovation behavior in response to the subsequent acceptance of the operating performance by the local government. These together lead to a situation where the number of patents goes up, but the quality of the patents goes down. The main reason for this is the hidden subsidies in the land investment by local governments. The more the land is subsidized, which indicates the lower land prices, the more it encourages firms to increase the number of patents, which we call it the incentive distortion.

We then empirically test our theoretical hypotheses. We match the Annual Survey of Industrial Firmsand the Patent Database with the Records of Industrial Land Transfer, and employs the Propensity Seore Matching and Diference-in-Differences(PSM-DID) approach to estimate the effect of land-based investment invitation on firms’ strategic innovation behavior. The empirical results of this study support our model predictions. We find that: Firms that have aequired land demonstrate a significant increase in patent numbers but a significant decrease in patent quality compared to those that have not acquired land. This indicates that the land-based investment invitation of local governments indeed lead to strategic innovation behaviors among firms. Belore getting the land, firms try to meet the criteria that show they canbe innovative in terms of patent numbers, since local governments prefer high-tech firms whentransferring industrial land. After they get the land, they continue to foeus on meeting the standards thatcheck their innovation output. Besides, this strategic innovation behavior is especially pronounced in firms that have obtained land through agreements and in special economic zones, since during the land transfer through agreements and in special economic zones, local governments are more likely to use "hidden subsidies" to manipulate the transler of industrial land, thereby resulting in a stronger incentive distortion.

Our findings suggest that local govemments should be aware of how their land transfer can distort theway firms innovate, so as to improve the innovation efficiency and promote China's transformation from an ''a leading innovative country" to an ''a leading innovative country of quality". To mitigate the incentive distortion caused by local governments’ land-based investment invitation pattern, it is recommended that the government enhance its ability to discern patent quality. Establishing innovation assessment criteria that balance both the quantity and quality of innovation can reduce the information asymmetry between the government and firms, Furthermore, it is advised that local governments shouldclearly deline land prices or rent benchmarks to reduce the space for local government competition through "hidden subsidies" in land transfer system, This encourages a well-ordered and competitive industrial land transfer system, promoting the flow of land resources to high-efficiency and high-quality firms, and stimulating more numbers and higher quality of patents at the same time. That is to say, the market' s decisive role in land resource allocation should be leveraged to deepen land supply-side reforms and the marketization of industrial land transfers, including encouraging competitive land transfer approaches such as bidding, auctioning, and listing. 

This can significantly reduce the proportion of agreement transfers in industrial land allocation, using the ''invisible hand" to achieve efficient allocation of resources needed for innovation. Also, Special economic zones should also be encouraged to innovate their systems, incorporating economic growth quality, including patent quality, as a binding indicator in their development plans.

Keywords: Land Based Investment lnvitation; Information Asymmetry; Policy Incentive