Trade, Growth, and Product Innovation

TL;DR

This paper investigates how trade integration, exemplified by EU enlargement, stimulates product innovation and growth, using a new dynamic model that decomposes trade gains into static and dynamic components.

Contribution

It introduces a novel quantitative framework combining specialization and market size, and quantifies the impact of trade on innovation and growth, including welfare effects.

Findings

EU enlargement increased long-run growth by about 0.10 percentage points.

Dynamic gains from trade account for 65-90% of total welfare gains.

Market access significantly boosts product innovation and export probabilities.

Abstract

Can trade integration induce product innovation? I document that countries that joined the European Union (EU) started producing more product varieties, investing more in R&D, and trading more compared to candidate countries that did not join at a given horizon. Additionally, I show that a plausibly exogenous increase in market access increases the probability of a given country starting production of and exporting a given product. To rationalize this reduced-form evidence, I propose a new quantitative framework that integrates the forces of specialization and market size. This is a dynamic general equilibrium model of frictional trade and endogenous growth with arbitrarily many asymmetric countries that nests the Eaton-Kortum model of trade and the Romer growth model as special cases. The key result is an analytical expression to decompose gains from trade into dynamic and static components. In this framework, the product innovation growth rate increases with higher market access. Finally, a quantitative version of the model suggests that: (a) the EU enlargement increased its long-run yearly growth rate by about 0.10pp; and (b) dynamic gains can account for between 65-90% of total welfare gains from trade.