Trade increases competition and hence the incentive, and in some cases the means, to innovate. Stronger competition has been shown to have particularly powerful effects on productivity in countries far away from the technological frontier.
A more competitive environment in Australian motor vehicle production and in shipbuilding – in the first case via reduced import barriers, in the second through reduced subsidies – helped foster innovation and increased productivity. In shipbuilding, an important element of innovation was the technical shift from production in steel to the use of composite materials. In the case of the motor vehicle industry, a key element was organisational efficiency in the shift to just-in-time inventory management.
Reduced domestic support and tariff protection encouraged New Zealand agriculture to adopt and absorb new technology, thereby enhancing productivity. Innovation ranged over agro-technology, animal genetics, software applications, agricultural tourism and biochemical businesses. It made New Zealand more responsive to international customers and this is trun induced further innovation – chilled meats, low fat lamb, and new dairy products.
Particularly where trade involves foreign direct investment or the movement of skilled personnel, it is likely to promote the transfer of technology and expertise, and thereby innovation.
The development of the Kenyan cut flower industry benefited greatly from technology embodied in foreign direct investment from Holland.
When the United States increased the number of people allowed to enter the US under the H-1B visa programme by 10%, total patenting increased by 2%, spearheaded by more patenting by immigrant scientists.
Beyond this direct transfer of technology, there is also an indirect contribution as trade serves to lower prices and hence the cost of accessing superior technologies.
Trade allows firms to exploit economies of scale. Companies producing for both the domestic and foreign markets are better able to recoup R&D investments over a larger quantity of sales than if selling only for the domestic market. It also allows trade-exposed firms to identify new opportunities based on their core strengths.
The textile and clothing sector of Sri Lanka has ventured into India in order to reap the advantages of a larger market potential. To become the global player that it is today, Nokia had to expand beyond the small local market of Finland.
Trade and trade reform can help foster intra-industry trade and the globalisation of value chains in a number of ways: by promoting harmonisation around international technical standards to which firms in fragmented value chains must conform; by addressing the danger that restrictive rules of origin (designed to ensure that only imports from partners in bilateral or regional agreements have preferential access) will disadvantage low-cost suppliers within the chain; and by encouraging measures that facilitate trade, enabling suppliers to respond quickly to developments further down the value chain.
Globalisation of value chains can be associated with increased specialisation and efficiency. In the last 25 years, trade in intermediate products has grown from 42% to 60% of total intra-regional trade in East Asia, far outstripping trade in raw materials (8%) and finished products.
Intellectual property protection boosts innovation, but also makes innovation less likely to be transferred. The World Trade Organization (WTO) TRIPS agreement established minimum standards for intellectual property rights (IPRs) protection as part of the rules-based multilateral trading system. There remains an active debate as to the appropriate degree of protection beyond the basic requirements of TRIPS, but the notion of the need for a balanced system to protect IPRs is well established. The rationale is, in part, linked to concerns about market failure; without limits on imitation, the private returns on innovation may indeed be lower than the public returns, and the supply of innovation correspondingly reduced.
Recent analysis shows the positive link between IPR protection and increased transfers to developing countries of technology-intensive goods, services and capital. A 1% strengthening in patent protection in developing countries is associated with a 1.6% increase in the stock of inward FDI. Perhaps even more importantly, research shows a strong positive link between patent protection and innovation within developing countries.
In conclusion …
These links between trade and innovation depend not only on the institutional context in which they operate, but also on the broader economic environment. Trade-related innovation will only flourish where the overall policy framework is conducive to change and transformation of existing products and processes.