Technology and the dynamics of comparative advantage

This paper explores how trade openness affects both product and process innovation in a factor proportions model of trade and firm heterogeneity. Trade openness expands the profit opportunities of the most productive firms and expels the less efficient firms out of the market, making process innovation more attractive for the most productive firms in both industries. Incentives, however, are larger in the industry in which the country has the comparative advantage. Trade also increases the profits of prospective entrants leading to an increase in product innovation in the comparative advantage industry. In addition, I obtain a non-monotonic relationship between trade costs and a country's trade pattern: When the level of trade costs are high, a reduction in trade costs leads to an increase in process innovation in both industries, being stronger in the comparative advantage one; when the trade costs are low the effect is stronger in the comparative disadvantage one. This final result could rationalize recent empirical findings suggesting that in the last half century the Ricardian comparative advantage has become weaker over time.