Technology and innovation play an increasingly important role in the economic development of both developed and developing countries. We investigate how policy and market factors influence firms’ (or other potential innovators’) decisions on innovation or imitation by developing a conceptual model and then empirically testing it using pesticide innovation data from a rapidly developing country, China. We find that the government encouraged local innovation by opening regions to more international trade, more investment in public research and education, strengthening intellectual property right (IPR) enforcement, and limiting the role of foreign inventors. However, the role of the extension of patent life in the early 1990s has little impact. Theory and some of our measures of market size suggest that this factor also is important, but the empirical evidence is mixed. The results suggest that the government policies for openness, public research and education and IPR enforcement can encourage innovation. Limiting foreign invention could encourage more local patenting but might limit Chinese farmers’ access to new technology.