For all the narrative around the disruptive nature of innovation, it’s fairly rare for innovators to fully capture the value of their invention.  It has long been argued that this mismatch disincentivizes innovation, which in itself creates a mismatch between the potential benefits we could see from an innovation and the reality.

Recent research from Stanford explores how international trade can play a role in sparking not only more growth but also more innovation.  The researchers argue that a rise in competition from exporting foreign firms forces domestic laggards to adopt more efficient practices.

“You can think of it like this: If everyone else is moving ahead faster and you’re standing still, then you’re falling behind faster,” they say. “And if you’re falling behind faster, you’ll probably choose to upgrade your technology more often.”

Keeping up

Typically, we are led to believe that free trade helps large and productive firms that are already exporting their wares because they’re better able to capitalize on the opportunity.  As such, they tend to squash the competition, which may consist of smaller and less sophisticated rivals.

“In a traditional model, that’s sort of the end of the story,” the researchers continue. “In our model, a key innovation is that we give those smaller firms some activity they can do in response: Instead of having to sit there and take it, they can get better.”

Of course, given the global village facilitated by the internet, we might reasonably assume that ideas can travel fairly easily, but the market for ideas is not always so neatly efficient and clear inefficiencies often appear between those at the leading edge and those lagging behind.  The authors argue that the introduction of external competition can shake up an internal market and prompt domestic firms to up their game.

Previous studies have suggested these factors are only marginally important, with gains of around 1% likely.  The new study suggests that gains are significantly greater, and improvements of 10% or more are quite probable.

Equitable distribution

Of course, the authors are at pains to point out that their work doesn’t cover the equity of any innovation or the effect of trade on things such as employment in particular industries, regions, or even demographic groups.

“There is a whole separate branch of economics literature on trade that tries hard to study the distributional implications of policy,” they say. “These two complement each other — you want to know what’s happening to the whole pie and you want to talk about how to slice it up.”

For instance, a more open border policy on trade can create gains in the aggregate, but it will also create winners and losers among individual firms.  It’s the role of policymakers to ensure that any gains are distributed so that all of society benefits from them.

“It’s probably true that a lot of people in America, and across the world, have been hurt by international trade proliferation,” the researchers conclude. “But if that fact stops us from further integrating economies, further lowering trade barriers, then my paper suggests we’re leaving a lot on the table. We just have to put the distributional policies in place to take care of those who are hurt.”