Trade Liberalization, Export and Product Innovation

TL;DR

This paper examines how trade liberalization, exemplified by China's WTO accession, influences firms' export behaviors and product innovation, revealing that trade liberalization promotes innovation through increased export incentives and dynamic productivity improvements.

Contribution

It provides both theoretical and empirical evidence that trade liberalization incentivizes firm innovation and export activities, highlighting an unintended positive effect of trade policy changes.

Findings

Trade liberalization reduces trade costs and boosts exports.

Exporting firms are more incentivized to innovate.

Innovation leads to higher productivity and lower future entry costs.

Abstract

This paper studies firms' optimal response to a trade liberalization shock in terms of export and product innovation both theoretically and empirically. We find that trade liberalization, namely China's WTO accession, reduces trade cost and promotes export, which in turn incentivizes firms to innovate as the marginal benefit of innovation for exporting firms is higher than that for non-exporting firms. In addition, as a firm starts to innovate, it predicts to have a higher probability of moving to a better productivity state and can save the entry cost of innovation in the future, resulting in additional dynamic benefits. Such an innovation-promotion effect is an unintended consequence of trade liberalization.