Why doesn't curbing corruption always improve service outcomes? I argue that gaps in formal institutions create room for corrupt exchanges that provide integral organizational support. As organizations become dependent on these exchanges, curbing corruption can also remove operating capacity. Drawing on over twelve months of fieldwork in China's health sector, I identify two mechanisms through which privately beneficial corruption becomes publicly useful: (1) efforts to conceal payments and advance professional careers channel resources into publicly beneficial investments in hospital equipment, research, and staff training; and (2) trust among bribe givers and recipients, built through repeated exchange, facilitates information sharing and flexible credit.

To test this argument empirically in China's public hospitals, I use AI-assisted extraction of health yearbooks and firm disclosures and construct a novel proxy for reliance on corruption-generated resources with the pre-reform drug share of outpatient expenditure. Leveraging the staggered rollout of China's National Volume-Based Procurement reform, which centralized drug purchasing to constrain hospital discretion and curb corruption, I compare early- and later-exposure provinces in a difference-in-differences analysis covering all 31 provinces over 2010–2023. Contrary to standard accountability expectations, early exposure to reform was associated with higher rather than lower outpatient bills: an additional RMB 46.23 per visit, equivalent to 18% of the 2017 national average bill. Consistent with the argument that corruption fills gaps in formal support, this counterintuitive increase was especially pronounced in provinces with greater prior dependence on drug-linked informal resources. For every ten-percentage-point higher pre-reform drug share, the estimated increase was RMB 76.25 larger, equivalent to 30% of the 2017 national average outpatient bill. This pattern persists across alternative measures and specifications. Complementary analyses show sharp procurement-price reductions for covered drugs and declining selling-expense shares among firms, consistent with a real decline in corruption despite rising bills. The findings suggest that anti-corruption can expose formal deficiencies previously concealed by informal support. Lasting service improvements require not only curbing extraction, but also replacing lost funding and coordination.

How did China emerge as a global leader in pharmaceutical innovation when domestic cost containment reforms compressed the generic-drug profits that financed research? Existing scholarship emphasizes domestic regulatory and commercialization institutions but pays less attention to how innovation proceeds while these institutions are still developing. This paper develops a two-step argument: domestic reforms pushed firms toward drug development by undermining their established business model, while access to global markets through cross-border licensing helped sustain that transition.

In the first part of the paper, I link 4.1 million pharmaceutical sales records with drug registrations and licensing transactions to investigate how domestic cost containment stimulated a shift toward innovation by making generic production less profitable. I measure reform exposure across 1,035 firms using their pre-reform product and geographic sales portfolios. A continuous-exposure difference-in-differences analysis shows that greater exposure to cost containment reform is associated with a reorientation toward drug development.

However, pressure to innovate does not itself provide the commercial returns needed to sustain research. In the second part of the paper, I examine how firms sustained this transition when reform pressure outpaced domestic institutional support. I identify the global market for novel drugs as an alternative source of institutional support, with cross-border licensing providing financing and access to overseas markets. Out-licensing is an arrangement in which a domestic firm grants a global partner commercialization rights in specified overseas markets in exchange for an upfront payment that can finance further research at home. Combining risk-set matching with stacked difference-in-differences, I compare firms completing their first license-out with firms exhibiting similar development histories and reform exposure. Firms securing these deals sustain larger increases in domestic clinical activity, with an estimated 10.2 additional weighted Phase I–III trial registrations for novel drugs over three years relative to matched firms and no comparable increase in bioequivalence registrations.

The findings have three implications. First, China illustrates a recurring dilemma of industrial upgrading. Domestic institutions are costly and difficult to build, yet firms need institutional support to develop innovative capabilities. Cross-border licensing offers a way through this sequencing problem, allowing innovation to advance while domestic institutions develop. Second, as pharmaceutical innovation shifts toward Asia, this pathway raises distributional questions about who bears the burdens of clinical trials and who gains access to the resulting drugs. Third, the findings underscore the importance of international cooperation in sustaining innovation, even amid heightened political tensions.