R&D in the Network of International Trade

Recent empirical evidence has shown that trade liberalization promotes innovation and productivity growth in individual firms. This paper argues that different types of trade liberalization – multilateral versus regional – may lead to different R&D and productivity levels of firms. Trade agreements between countries are modelled with a network: nodes represent countries and a link between the nodes indicates the existence of a trade agreement. In this framework, the multilateral trade agreement is represented by the complete network while the overlap of regional trade agreements is represented by the hub-and-spoke trade system. Trade liberalization, which increases the network of trade agreements, reinforces the incentives for firms to invest in R&D through the creation of new markets (scale effect) but it may also dampen these incentives through the emergence of new competitors (competition effect). The joint action of these two effects within the multilateral and the regional trade systems gives rise to the result that, for the same number of direct trade partners, the R&D effort of a country in the multilateral agreement is lower than the R&D effort of a hub but higher than the R&D effort of a spoke. This suggests that a ”core” country within the regional trade system has higher R&D and productivity level than a country with the same number of trade agreements within the multilateral system whereas the opposite is true for a ”periphery” country. Additionally, the paper finds that while multilateral trade liberalization boosts productivity of all countries, regional trade liberalization increases productivity of core economies but may decrease productivity of periphery economies if the level of competition in the new trade partner countries of the periphery economy is ”too high”. Furthermore, the aggregate level of R&D activities within the multilateral trade agreement exceeds that in the star – the simplest representative of the hub-and-spoke trade system.