Equilibrium Technology Diffusion, Trade, and Growth

How do reductions in barriers to international trade affect aggregate economic growth and welfare? We develop a novel dynamic model of growth and trade, driven by technology adoption, to better understand the interaction between technology diffusion, openness, and growth. In the model, heterogeneous firms choose to produce and trade or pay a cost and search within the economy to upgrade their technology. These upgrading and production choices determine the productivity distribution from which firms can acquire new technologies and, hence, the rate of technological diffusion and growth. In equilibrium, low productivity firms choose to upgrade their technology to remain competitive and profitable. Lower trade barriers enhance competitive forces that differentially affect firms of varying productivity levels. Lower barriers tend to reduce profits for all domestic firms by creating added competition from foreign firms, but improve profits for the highly productive firms by providing expanded opportunities through exporting. This shift in the relative value of firms provides increased incentives to upgrade technology, which are counterbalanced by an increasing cost of upgrading technology due to general equilibrium effects. In our baseline calibration, an increased growth rate generates a dynamic component of welfare that magnifies the traditional static component to increase the welfare gains from openness.