Idea Flows, Economics Growth and Trade

Abstract

We provide a theoretical description of a process that is capable of generating growth and income convergence among economies, growth that is accelerated by freer trade. In this model freer trade replaces inefficient domestic producers with more efficient foreign producers. We add to this static effect a theory of endogenous growth where the engine of growth is the flow of ideas. Ideas are assumed to diffuse by random meeting where people get new ideas by learning from the people they do business or compete with. Trade then has a selection effect of putting domestic producers in contact with the most efficient foreign and domestic producers. We analyze the way that trade in goods, and impediments to it, affect this diffusion, above and beyond the standard effects of trade costs. We find that exclusion of a country from trade reduces the productivity growth, with large long term effects. Smaller trade cost have moderate effects on productivity. The theory also provides a new foundation for the Frechet distribution of productivity that is frequently used in quantitative trade models.