Trade Liberalization and Ambiguous Effects on the Long-run Growth : R&D-based Endogenous Growth Model with Horizontal Innovations and Heterogeneous Quality Levels

Exporting abroad is relatively rare activity. Only large, high productive firms with high-quality goods are involved in international trade. Self-selection effect drives high productive firms with high quality goods to export, less productive firms with lower-quality products serve only domestic market, and non-profitable firms with quality lower than domestic cutoff quality level exit the market immediately. Resource reallocation shifts skilled labor from manufacturing to R&D sector when less productive firms exit the markets. R&D-based endogenous growth model presented here assumes that all firms face same ex-ante probability to survive and zero probability of default. After paying learning costs firms occur own quality level and decide whether to enter markets or not. Trade liberalization extend the size of market and gives opportunities to efficient firms become exportes. Analysis of the model concludes that trade has ambiguous effects on the long-run growth. Freer trade increases knowledge spillovers and has pro-growth effect. However, trade liberalization increases domestic cutoff quality level and consequently R&D costs in innovation sector. Increasing expected sunk costs decrease motivation to innovate and therefore also slow down investments in R&D sector. Increase in effective discounted rate also decreases expected discounted benefits and has negative effect on growth rate. Consequently, a move from autarky to trade has ambiguous effects on the long-run growth and on average global quality level. Model presented here is based on research paper written by Dinopoulos and Unel, 2011: Quality Heterogeneity and Global Economic Growth