Quality of imported intermediates, innovation behaviour and markups: Firm‐level evidence from China

This paper examines whether higher quality imported intermediates can increase firms' markups. Based on the conceptual model, we first find that improving the quality of imported intermediates affects firms' decision‐making in terms of innovation and firm‐level markups through the price channel and the cost channel. We combine the annual survey data of Chinese industrial firms (ASIF), Chinese customs transactions and patent data to verify the theoretical propositions. The results report that: (1) there is a significantly positive correlation between the quality of imported intermediates and firms' markups; (2) innovation acts as a potential channel through which the quality of imported intermediates increases firms' markups; (3) by decomposing markups into the price channel and the cost channel, we find that the quality of imported intermediates affects firms' markups through the cost channel. Our results suggest that higher quality imported intermediates may improve firms' market power through innovation.