International technology diffusion via goods trade: Theory and evidence from China

Technology plays an important role in determining productivity at the firm and country level and this in turn determines the economic growth and performance of countries. Most research on technology diffusion focuses on channels such as FDI and licensing. Reverse-engineering is an important channel of diffusion but has received almost no attention in academic studies even though it is controversial and has been singled out in technology policies such as trade-related aspects of intellectual property rights (known as TRIPs) in the World Trade Organization (WTO). This paper develops a multi-product firm model with endogenous decisions on export and reverse-engineering of imported products to study technology diffusion via goods trade. The productivity embedded in a given product of a given firm has two components: firm-level ability that is common to all the products within the firm; and firm-product level expertise that is specific to a given product of the firm. The ability and the expertise are complementary in production. The model predicts a product-level self-sorting pattern within a firm whereby a firm will reverse-engineer and export the product of his best expertise, export the product of his medium expertise and sell the product of his lowest expertise only in the domestic market. We test the firm- and product-level predictions of the model using the product-level trade data from China. We find strong empirical support on the firm-level self-sorting pattern that the more productive firms are more likely to reverse-engineer the imported products and export those products. We also find that by reverse-engineering the imported products, a firm assimilates the technology or the knowledge embedded in the product so that he can upgrade the quality of the exports and reduce the prices. The efficiency improvement of a product further implies gains from trade through resource reallocation within firms toward the product. Reverse-engineering exporters also charge less for their exports and the prices drop when they reverse-engineer the imported products, which reflects the productivity gains. Furthermore, reverse-engineering firms are found to expand more quickly along the extensive margins of the export. On average, reverse-engineering exporters export their product to 0.7 more destinations than the pure exporters and they add 0.4 more destinations to their destination pool. The reverse-engineering exporters also export 1.4 more products and they add 0.4 more products to their product mix.

JEL: F12,F14,O33