404/2019 Ana Maria Santacreu and Liliana Varela

This paper studies the impact of increased import penetration on a country’s long-term patterns of trade. It shows that foreign competition induces firms to increase their R&D efforts in order to differentiate their products and escape competition. Quality improvements translate into increases in firms’ exports. This effect, however, is heterogeneous across sectors and is driven by sectors’ in which the country has a comparative advantage. On the aggregate, the impact of import competition on innovation and a country’s patterns of trade depends crucially on the distribution of sectoral comparative advantage. We provide evidence of this mechanism using firm-level data on trade and innovation for France and import competition driven by China’s WTO entry.

Political Economy