“Import Competition, Multi-product Firms and Basic Innovation” by Runjuan LIU
University of Alberta
How does firm strategy to produce basic innovation depend on international trade? Given that in the modern economy trade and innovation are prominent in raising welfare, better understanding of this question is essential. In this vein we combine patent, firm, and trade data to show that when confronted with higher import penetration, firms produce innovations with more modest externalities. That is, the data consistently suggest that a negative relationship exists between the basic nature of innovation and the degree to which innovating firm are exposed to competing imports. We propose that underlying this result is the interplay between multi- product firms that narrow their product scope when exposed to greater import competition and the difficulty inventors face when capturing all benefits derived from their basic innovations. To verify our hypothesis of this indirect channel through which innovation is affected, we find supporting evidence in the data. In merging elements of the trade literature on multi-product firms and Nelson's diversification hypothesis (1959), this paper is novel and highlights significant considerations for both trade and innovation policy.