Innovation in a Shrinking World

This paper explores the implications of reductions in tariffs or transport costs on the rate of innovation in a quality ladders model where Þrms from both countries innovate. If a country raises its tariffs, its wage rises relative to the other country and its Þrms become technology leaders for a larger fraction of products, but the aggregate rate of innovation falls. If transport costs fall symmetrically everywhere, then the aggregate rate of innovation rises, absent distributional consequences across countries. Additionally, diffusion of innovation technology to Þrms in the foreign country generates effects similar to a unilateral reduction in the protection of domestic markets through tariffs.