Innovation, Diffusion and Trade: Theory and Measurement∗

In the last decade, some countries in Asia and Europe grew much faster than average, and experienced a significant increase in the variety of goods that they import. At the same time, their investment in R&D is low: 80 % of the innovative activity in the world is concentrated in a few rich countries. This evidence suggests that non-innovative economies benefit from foreign technology through imports. I propose a general equilibrium model of innovation and international diffusion to analyse the connections between trade in varieties and economic growth. International diffusion occurs through the adoption of new goods that have been developed elsewhere. In this context, trade arises as the natural vehicle of diffusion. The model is able to capture the main features of the data: countries innovate, adopt, and grow at different rates. The model is fitted to five regions: Asia, Eastern Europe, Western Europe, Japan and the US. Using disaggregated trade data, and data on the fraction of workers allocated to R&D, and output growth, I estimate the parameters of innovation and diffusion with Bayesian techniques. I then decompose the sources of productivity growth in each region. The results show that 90 % of growth in Asia is explained by imports from the US and Japan. These two regions are also the main sources of foreign technology for other regions in the model. Finally, I carry out counterfactual analysis to examine the connections between trade and growth by changing various exogenous parameters. A 10 % permanent decrease in the barriers to technology adoption in Asia increases world growth rates by 0.4%. In the tran-sition, Asia imports and grows faster than the rest of the world. A 10 % permanent increase in the innovation productivity in Asia increases world growth rates by 0.7%. The higher productivity in Asia increases the demand of imports by this region by 6%. Thus, either change leads simultaneously to both higher growth and more trade. ∗I am very grateful to Jonathan Eaton for his support and guidance. I am also grateful to Francisco Alcala