Technology and the dynamics of comparative advantage

This paper explores how trade affects innovation in a two-country, two-good, twofactor Heckscher-Ohlin model with heterogeneous firms. Trade openness induces an increase in process innovation in both industries. The increase is stronger in the comparative advantage industry. Trade openness boosts prospective entrants’ profits in that industry which leads to further increases in product innovation. Trade liberalisation generates a different relative impact on innovation across industries, depending on trade costs. When they are high (low), it increases process innovation relatively more in the comparative advantage (disadvantage) industry, leading to TFP divergence (convergence) across industries.