Trade War and Technology Rivalry

The paper presented in this ZEW Research Seminar develops a quantitative trade model with endogenous innovation and trade-driven technology diffusion to study how trade policies shape global technology rivalry. In the model, trade policies affect technology through two channels: by changing knowledge flows embodied in trade and by changing firms' market sizes, and hence their returns to innovation. The authors estimate the model’s key parameter - the elasticity of international knowledge diffusion, proxied by patent citations, with respect to trade flows - using quasi-experimental shocks to global trade patterns. Armed with the estimated model, they quantify the effects of U.S. export controls on China and of the Liberation Day tariffs, showing that (i) export controls dampen technological capabilities in both countries, with China experiencing a decline in technology inflows and the U.S. facing a decline in R&D investments, and (ii) endogenous innovation and trade-driven technology diffusion substantially amplify the technology and welfare losses from the Liberation Day tariffs in China and other major economies. They further quantify the U.S. unilaterally optimal tariffs on China, highlighting the trade-off between restricting technology diffusion to China and sustaining U.S. innovation.