Comparative Advantage in Innovation and Production

This paper develops a dynamic model of innovation and international trade in which agents can direct their research efforts to specific goods in the economy. Trade affects the direction of innovation through its impact on the expected market size for an invention, leading to a two-way relationship between trade and technology absent in standard quantitative Ricardian models. Following a theory-consistent strategy to estimate the extent of endogenous adjustments in technology, I find that they can account for about half of the observed variance in comparative advantage in production in a sample of 29 countries and 18 manufacturing industries. In addition, the model suggests that standard Ricardian models overestimate the reductions in real income from increases in trade costs and underestimate the rise in real income due to trade liberalizations. (JEL F11, F14, L60, O31, O32)