The tangible benefits of global trade are widely recognized by researchers and felt by ordinary people daily. You might be reading this blog on a device assembled in China, sipping coffee brewed from Colombian beans, and wearing clothes made in Bangladesh. Perhaps you are checking the time on a Swiss watch or getting ready to commute in a German car. What is less commonly acknowledged, even among experts, is that trade also fuels innovation.
Beyond goods and services, trade transmits ideas, technologies, and efficiencies that spark breakthroughs and drive long-term growth. In today’s rapidly evolving global trade landscape, we should ask how – and to what extent – barriers to importing and exporting affect American innovative capacity.
The current body of literature suggests that trade is a two-sided coin when it comes to innovation: On one side lies access to advanced technologies, knowledge spillovers, and greater productivity. On the other, trade can disincentivize domestic research and development and create risks of over-reliance on foreign capital.
Imported goods benefit consumers by offering a greater variety of products, often at lower prices. Firms, perhaps even more importantly, benefit through technological innovation. Numerous countries have “leapfrogged” intermediate stages of technological development by adopting newer, more advanced technologies directly. While this phenomenon is most observed in developing countries, it also occurs in the United States. For years, the U.S. lagged in producing the most advanced semiconductor chips, relying heavily on imports from firms in Taiwan and South Korea. But now, following the enactment of the CHIPS and Science Act, the very same Taiwanese firm it once imported from is set to build the most advanced chips on American soil. Without prior exposure to superior foreign technology, the U.S. might have been stuck developing chips gradually in isolation.
Leapfrogging is one way firms benefit from imports. Another important channel is knowledge spillovers. A 2011 paper, Imports, Innovation, and Employment after Crisis, found that importing intermediate inputs leads to higher rates of product adoption, expanded product scope, and reduced production costs for Ecuadorian manufacturing firms. In short, by using these advanced inputs, firms learn from them, eventually gaining the capability to implement similar innovations themselves. In some cases, they could even begin producing the inputs domestically.
Interestingly, exporting goods also produces numerous benefits for businesses. In the late twentieth century, researchers found convincing evidence that firms exporting goods abroad, compared to those that exclusively produce domestically, tend to become more productive, a phenomenon explained by “learning by exporting.” Heightened competition pressures firms to innovate, but exporting can also expose firms to new technologies, production methods, and management techniques from their foreign counterparts, suppliers, or even competitors. Export controls are usually justified on the basis of national security, but it is worth bearing in mind that by limiting firms’ access to global markets and international collaboration, they can inadvertently stifle innovation, reduce R&D investment incentives, and potentially hinder a nation’s long-term technological leadership.
In light of these potential gains, trade might seem like an obvious boon for American business and innovation. However, the economy is a delicate balancing act, and if trade policy overlooks factors like competition and supply chain vulnerabilities, it risks threatening the very industries that stand to benefit from trade when managed properly.
On a fundamental level, imports represent an influx of competition into U.S. markets. Classical economic theory generally tells us that competition, by incentivizing firms to differentiate themselves in the pursuit of market share and efficiency, spurs innovation. Too much competition, though, can also hinder innovation if thin profit margins leave insufficient funds available for research and development. This dynamic is captured by the “Inverted U” phenomenon. A 2002 paper, Competition and Innovation: An Inverted U Relationship, demonstrates that the impact of product market competition on innovation is not linear, but rather an inverted U-shape. Moderate competition fuels innovation through an “escape-competition” effect, while excessive competition can stifle it by eroding profit incentives. An illustrative example lies in the U.S.-China relationship. A 2017 study, Foreign Competition and Domestic Innovation: Evidence from U.S. Patents, finds that U.S. industries and firms exposed to greater import exposure from China show smaller increases in patenting, signs of less invention.
Beyond the challenge of excessive foreign competition lies another risk: becoming overly reliant on foreign suppliers. Over reliance poses a threat to American innovation in two ways. Firstly, if an industry depends too heavily on a single foreign supplier for a critical input, any disruption to that supply chain – whether caused by external shocks or geopolitical dispute – can halt production in the United States. For example, the supply of rare earth elements from Chinese firms enables U.S. businesses to produce many emerging technologies. However, as recent geopolitical tensions have demonstrated, this dependence represents a vulnerability that could jeopardize American technological prowess and progress alike. Second, there is the risk of losing domestic manufacturing capacity, often described as “hollowing out.” Competition from abroad drives prices down, which benefits consumers but can erode profits for American firms, threatening their ability to sustain production and invest in innovation.
The advantages of free and open international trade are widely acknowledged, yet its impact on innovation remains less comprehensively understood. Given innovation’s imperative role in our nation’s growth, stability, and quality of life, and especially in light of recent tariffs, policymakers should more deliberately consider trade policy’s implications and prioritize achieving the delicate balance between trade and innovative potential.
Written by Jackson Murray, Public Policy Intern
The Alliance for Innovation and Infrastructure (Aii) is an independent, national research and educational organization working to advance innovation across industry and public policy. The only nationwide public policy think tank dedicated to infrastructure, Aii explores the intersection of economics, law, and public policy in the areas of climate, damage prevention, eminent domain, energy, infrastructure, innovation, technology, and transportation.