Innovation, network externality, and international trade

The dissertation consists of three essays exploring the effects of innovation on the extensive margin, the intensive margin, and the duration of exports, as well as the influence of network externality and products compatibility on firms' FDI decisions. An important prediction of international trade theories is that countries which innovate more will export more. However, these theories have very different implications for how innovation would increase exports. In the first chapter, I empirically investigate the extent to which innovation increases the number of products (the extensive margin) and the export value of each product (the intensive margin). Using data on patents granted by the United States and data on manufacturing exports from 105 countries to the U.S. market over the period 1975-2001, I find that innovation has positive and significant effects on both the extensive and intensive margins. The intensive margin contributes about 70% of the effects, and the extensive margin accounts for the remaining 30%. The estimated results indicate that the effect of innovation on exports is stronger in low-income countries than in high-income countries. It is also stronger in industries which have relatively more differentiated products than homogeneous products. Finally, more innovative countries export larger quantities at higher prices, suggesting that innovation increases the product quality of exports.The second chapter continues studying the impact of innovation on exports, but the focus is switched to the dynamic pattern of trade. I use the survival analysis to investigate the effect of innovation on the duration of exports at the product level. The estimated results show that countries which have more innovations can sustain their export relationships for a longer period of time. The findings are consistent with the implication of the product cycle model, which stresses the role of innovation on dynamic trade patterns. The estimates also display that the duration of exports increases with country size and decreases with trade costs and barriers.Traditional trade theories explaining different FDI patterns across firms and sectors seek answers from the production side, such as the proximity-concentration trade-off and the factor-proportions hypothesis. The third chapter provides a new explanation for FDI (foreign direct investment) patterns from demand-side properties. I develop a differentiated-product duopoly model to analyze the effects of network externality (demand-side economies of scale) and product compatibility on firms' FDI decisions. The model is able to explain the following facts in FDI. First, firms producing compatible products are more likely to undertake FDI in the same location than firms producing incompatible products. Second, FDI is more prevalent in industries with strong network externality effects. This explains why FDI is more important in high technology industries. Third, a firm is more likely to undertake FDI if it has a larger installed base (more existing customers) in the foreign market. This is consistent with the fact that larger firms or firms with longer history are more likely to undertake FDI.