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Author:

• Dan LU
  University of Chicago

This paper explores technology diffusion by trade liberalization through spillovers by advanced foreign affiliates. Foreign firms conduct R&D as well as production in the host countries. Research outcomes depend on the overall knowledge in the host country and firms' innovation efficiency in a stochastic way. Successful research improves firm's productivity as well as overall knowledge in the country. We develop an analyically tractable model which endogenously determines firms' process of entry and exit and hence the stationary distribution. The entry of foreign firms changes the turnover of local firms and their distribution. Thus host countries are influenced by technology diffusion not only through a faster growing technology frontier, but also through the selection process. The model can be applied to many problem of industry equilibrium and may be used to analyze quantitatively the selection and growth of firms in open economy.