Innovation and Trade Policy in a Globalized World

Abstract

How do import tariffs and R&D subsidies help domestic firms compete globally? How do these policies affect aggregate growth and economic welfare? To answer these questions, we build a dynamic general equilibrium growth model where firm innovation endogenously determines the dynamics of technology, and, therefore, market leadership and trade flows, in a world with two large open economies at different stages of development. Firms' R&D decisions are driven by (i) the defensive innovation motive, (ii) the expansionary innovation motive, and (iii) technology spillovers. The theoretical investigation illustrates that, statically, globalization (defined as reduced trade barriers) has ambiguous effects on welfare, while, dynamically, intensified globalization boosts domestic innovation through induced international competition. Accounting for transitional dynamics, we use our model for policy evaluation and compute optimal policies over different time horizons. The model suggests that the introduction of the Research and Experimentation Tax Credit in 1981 proves to be an effective policy response to foreign competition, generating substantial welfare gains in the long run. A counterfactual exercise shows that increasing tariffs as an alternative policy response improves domestic welfare only when the policymaker cares about the very short run, and only when introduced unilaterally. Tariffs generate large welfare losses in the medium and long run, or when there is retaliation by the foreign economy. Protectionist measures generate large dynamic losses by distorting the impact of openness on innovation incentives and productivity growth. Finally, our model predicts that a more globalized world entails less government intervention, thanks to innovation-stimulating effects of intensified international competition.

The Heterogeneous Impact of Market Size on Innovation: Evidence from French Firm-Level Exports

“…Our work is also clearly related to the theoretical literature on trade, innovation and growth (see Grossman andHelpman, 1991a,b, Aghion andHowitt, 2009, chapter 13, and more recently Akcigit et al, 2018) 2 and the recent empirical literature on firm-level trade and innovation. Lileeva and Trefler (2010) and Bustos (2011) both highlighted a clear relationship between R&D efforts and export status.…”

The Impact of Trade Liberalization on Firm Productivity and Innovation

“…Since a reduction in access to foreign inputs and/or export opportunities is likely to hurt domestic innovation, protectionist policies have clear risks. Akcigit et al (2017) show in a model that import tariffs generate at best short-term gains at the expense of long-term losses,…”

“…Autor et al (2017),Akcigit et al (2017), andBloom et al (2018) provide informal discussions that focus on reconciling the differential findings between Europe and Northern America.6 Using data on Spanish firms,Chen & Steinwender (2017) provide support for the preference effect by showing that import competition has a positive effect only on initially unproductive family firms and not on professionally managed firms.…”

Optimal Trade Policies Under Product Differentiations

“…Acharya (2018) revealed that lobbying has significant effects on trade policy, resulting in government preference for import tariffs over export subsidies. Moreover, Akcigit et al (2018) provided some empirical evidence of the potential welfare losses generated from tariffs.…”