Optimal Trade Policy with International Technology Diffusion

We study optimal dynamic trade policies in an Eaton-Kortum model with technology diffusion through trade. The process of innovation and diffusion is one in which new ideas are combined with insights from others. Trade thus affects technology by determining the distribution from which producers draw their insights. Our theory shows that optimal policies capture a dynamic motive for a country to alter global technology. These policies take into account selection effects, country endowments, and other alterations to trade patterns that affect the degree and quality of diffusion. We provide explicit formulas showing that a Home country would like to subsidize imports from places that improve the quality of learning at Home; or lower its export tax to another country if a) higher productivity in that country is good for the Home, and b) more exports to that country improve the quality of learning and, in turn, the country’s technology. We also calibrate the model using cross-country data and quantify dynamic trade policies and their attendant welfare implications.