Trade, innovation and productivity

Empirical evidence shows that trade liberalization improves pro- ductivity not just because of a selection e ect but also because of productivity gains within rms. This paper proposes a model that allows for both channels, by adding the option to innovate to a trade model. In contrast to the existing literature, the process innovation is modeled as a continuous variable and there is both a xed and a variable cost to innovate. The interaction between the innovation and export choices is key to understand the di erent equilibria in the open economy and the outcomes following a trade liberalization. I calibrate the model to match the Spanish economy and explore the consequences of di erent trade policies. Simulations reveal that a trade policy that enhances innovation does not necessarily induce larger productivity gains.