Innovation and trade with heterogeneous firms

Abstract

This paper examines how trade liberalization affects the innovation incentives of firms, and what this implies for industry productivity and social welfare. For this purpose we develop a reciprocal dumping model of international trade with heterogeneous firms and endogenous R&D. We identify two effects of trade liberalization on productivity: a direct effect through changes in R&D investment, and a selection effect due to inefficient firms leaving the market. We show how these effects operate in the short run when market structure is fixed, and in the long run when market structure is endogenous. Among the robust results that hold for any market structure are that trade liberalization (i) increases (decreases) aggregate R&D for low (high) trade costs; (ii) increases expected industry productivity; and (iii) raises expected social welfare if trade costs are low.Keywords: international trade, firm heterogeneity, R&D, productivity, market structure AbstractThis paper examines how trade liberalization affects the innovation incentives of firms, and what this implies for industry productivity and social welfare. For this purpose we develop a reciprocal dumping model of international trade with heterogeneous firms and endogenous R&D. We identify two effects of trade liberalization on productivity: a direct effect through changes in R&D investment, and a selection effect due to inefficient firms leaving the market. We show how these effects operate in the short run when market structure is fixed, and in the long run when market structure is endogenous. Among the robust results that hold for any market structure are that trade liberalization (i) increases (decreases) aggregate R&D for low (high) trade costs; (ii) increases expected industry productivity; and (iii) raises expected social welfare if trade costs are low. JEL classification: F12, F15

A Theory of Trade Liberalization and Innovations with Heterogeneous Firms

“…Trade liberalization raises in the model of this paper a rm's expected export prots while at the same time lowering its expected domestic prots due to more import penetration. In contrast to other heterogeneous rms trade models and endogenous innovation (Long et al, 2011;Atkeson and Burstein, 2010), the incentive of a single rm to invest more in R&D as trade costs fall is not oset by stronger competition. Hence, at some degree of trade openness, a rm prefers to invest a higher amount of sunk costs in order to draw from a more favorable Pareto distribution.…”

“…In particular, it focuses on the impact of trade liberalization from a long term general equilibrium perspective. The model is therefore most closely associated with the work of Long et al (2011). In their oligopoly model with linear demand, entrants can also choose how much to invest in process R&D before knowing their productivity.…”

Should tax policy favor high- or low-productivity firms?

“…It is conceptually straightforward (but computationally non-trivial) to add a foreign investment opportunity for the low-cost multinational firms, thus combining firm heterogeneity with respect to both mobility and productivity in a single, unified setting. Another interesting extension would be to endogenize the cost differentials between different firms, for example by modelling different internal labor markets within large and small firms (Oi and Idson, 1999), or by incorporating R&D choices in a heterogeneous firms' framework (Long et al, 2011). Finally, from an empirical perspective, it would be highly desirable to subject our main hypothesis to a rigorous econometric test, linking quantifiable indicators of tax advantages for highly productive, multinational firms to the development of statutory corporate tax rates.…”

Trade and imperfect competition in general equilibrium

“…Drawing a line through P with the slope of the wage-rental ratio w yields combinations of factor allocations for which the relative income across countries stays constant. 15 Since preferences are homothetic, point C on this line, that is, the intersection with the diagonal 00 * , gives the point of implicit consumption of factors which depends on the share of world income only. As in DFS, although we cannot pin down production patterns, we can unambiguously determine the net factor content of trade.…”