TRADE, KNOWLEDGE SPILLOVERS, AND GROWTH

Endogenous growth of trading countries has been studied with international knowledge spillovers. These spillovers have typically been assumed to take place automatically. We study the growth performance of a small country in which scientific and technological knowledge flows from abroad are related to its extent of foreign trade. In this environment trade generates an externality that coexists with the externality of domestic innovation. The latter leads to too little innovation. We show that policies that reduce the extent of international trade strengthen the undersupply of innovation. Consequently the economy grows too slow for both reasons. In fact, some trade promoting policies reduce the harmful effects of the innovation externality, they accelerate growth and raise national welfare. © 1991.