Riding the Wave of Demand: How Does Domestic Demand Drive Innovation in Intermediate Goods?

【Authors】

DAI Feng, LV Lizhan & XUN Chen

【WorkUnit】

Nanjing Forestry University, 210037.

【Abstract】

In the face of escalating global trade protectionism and intensified technological blockades imposed by developed countries, China has increasingly turned to its ultra-large domestic market to strengthen its internal economic flows and hedge against uncertainties in the international market. This strategic shift is crucial for China to create a new pattern of development. Since the introduction of the reform and opening-up policy, China’s export-oriented development strategy has fostered a globally competitive production capacity of final goods. However, critical intermediate goods, such as key components and parts, have long relied on imports due to rapid technological iteration and complex industrial ecosystems, creating “strangleholds.” If domestic final demand fails to effectively stimulate innovation in intermediate goods, strategic blockades by Western nations could disrupt China’s economic cycle. Therefore, understanding how domestic demand drives innovation in intermediate goods is crucial for overcoming technological constraints, ensuring unimpeded economic flows, and accelerating the establishment of a new pattern of development.
This study employs the OECD’s latest World Input-Output Database and a Structural Decomposition Analysis （SDA） model to deconstruct the factors influencing China’s intermediate goods innovation between 2000 and 2020. It examines the causal relationship and underlying transmission mechanisms between domestic demand and innovation in intermediate goods. Key findings reveal that positive changes in China’s intermediate goods innovation are primarily driven by the innovation coefficient effect, followed by the domestic demand effect, and then the foreign demand effect. Of the domestic demand effect, investment demand has a stronger impact than consumption demand. Analysis by industry technology type shows that domestic demand-induced innovation exhibits significant advantages in medium- and high-technology industries. Incorporating the distinction between import demand and domestic demand within a causal identification framework, regression analysis confirms that domestic demand significantly induces intermediate goods innovation. The primary transmission mechanisms identified are the expansion of demand for intermediate goods and increased industry profits from intermediate goods. Industries dominated by enterprise procurement are more effective at harnessing innovation momentum from domestic demand than those dominated by consumer purchasing. This study enriches studies on demand-driven innovation and offers practical insights into exploring the endogenous drivers of intermediate goods innovation. 
Policy implications are threefold. First, establish a tripartite linkage mechanism of “consumption quality upgrading—investment structural shift—factors reconfiguration” to better leverage the guiding role of domestic demand in strengthening the domestic economic cycle. Second, enhance demand-side industrial policies and provide targeted support for critical sectors to foster an innovation ecosystem for domestic products. Third, prioritize the optimization of the innovation framework in industries dominated by enterprise procurement, while increasing imports of high-tech products to compel domestic firms toward innovation through competitive pressure.
Future research could leverage micro-level data on enterprises and consumers to explore how consumer heterogeneity influences upstream intermediate goods innovation.

JEL: O31, E21, E22

【KeyWords】

Domestic Demand, Innovation in Intermediate Goods, Structural Decomposition Analysis, Intermediate Demand, Intermediate Profit