Trade and Innovation
Two central insights from the Schumpeterian approach to innovation and growth are that the pace of innovation is endogenously determined by the expectation of future profits and that growth is inherently a process of creative destruction. As international trade is a key determinant of firm profitability and survival, it is natural to expect it to play a key role in shaping both incentives to innovate and the rate of creative destruction. In this paper, we review the theoretical and empirical literature on trade and innovation. We highlight four key mechanisms through which international trade affects endogenous innovation and growth: (i) market size; (ii) competition; (iii) comparative advantage; (iv) knowledge spillovers. Each of these mechanisms offers a potential source of dynamic welfare gains in addition to the static welfare gains from trade from conventional trade theory. Recent research has suggested that these dynamic welfare gains from trade can be substantial relative to their static counterparts. Discriminating between alternative mechanisms for these dynamic welfare gains and strengthening the evidence on their quantitative magnitude remain exciting areas of ongoing research.
We are grateful to Harvard University and Princeton University for research support. This paper was commissioned for the conference and book “The Economics of Creative Destruction” in Honor of Philippe Aghion and Peter Howitt. Thanks to Sam Kortum, Dan Trefler and participants at the conference for helpful comments. The usual disclaimer applies. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.