How do imported intermediate inputs affect service firms’ R&D investment? Evidence on mechanisms and heterogeneity from devel-oping countries

As imports of intermediate services have become an important channel for developing countries to build innovation advantages, it is crucial to understand how such imports shape service firms’ innovation investment. This paper develops a theoretical framework for the mechanisms through which intermediate service imports affect service firms’ innovation investment and tests the resulting hypotheses using an IV-Probit model and micro-level data on around 11,000 service firms in developing countries from the World Bank. The estimates show that larger imports of intermediate services in the host country significantly increase service firms’ R&D investment. Managerial experience, financing constraints, and operating performance are identified as key channels through which intermediate service imports influence innovation investment. Further analysis reveals pronounced heterogeneity in both the effects and transmission mechanisms across countries at different income levels, firms at different life-cycle stages, state-owned and non-state-owned firms, and exporting and non-exporting firms. The findings provide concrete implications for the design of China’s innovation and trade policies from the perspective of intermediate service imports.