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A trapped factors model of innovation

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  • Bloom, Nicholas
  • Romer, Paul
  • Terry, Stephen
  • Van Reenen, John

Abstract

When will reducing trade barriers against a low wage country cause innovation to increase in high wage regions like the US or EU? We develop a model where factors of production have costs of adjustment and so are partially “trapped” in producing old goods. Trade liberalization with a low wage country reduces the profitability of old goods and so the opportunity cost of innovating falls. Interestingly, the “China shock” is more likely to induce innovation than liberalization with high wage countries. These implications are consistent with a range of recent empirical evidence on the impact of China and offers a new mechanism for positive welfare effects of trade liberalization over and above the standard benefits of specialization and market expansion. Calibrations of our model to the recent experience of the US with China suggests that there will be faster long-run growth through innovation in the US and that, in the short run, this is magnified by the trapped factor effect.

Suggested Citation

  • Bloom, Nicholas & Romer, Paul & Terry, Stephen & Van Reenen, John, 2013. "A trapped factors model of innovation," LSE Research Online Documents on Economics 48920, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:48920
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    File URL: http://eprints.lse.ac.uk/48920/
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    References listed on IDEAS

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    1. Francisco L. Rivera-Batiz & Luis A. Rivera-Batiz, 2018. "Economic Integration and Endogenous Growth," World Scientific Book Chapters, in: Francisco L Rivera-Batiz & Luis A Rivera-Batiz (ed.), International Trade, Capital Flows and Economic Development, chapter 1, pages 3-32, World Scientific Publishing Co. Pte. Ltd..
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    More about this item

    JEL classification:

    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes
    • O38 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Government Policy

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