Abstract
We provide a tractable, quantitatively‐oriented theory of innovation and technology diffusion to explore the role of international trade in the process of development. We model innovation and diffusion as a process involving the combination of new ideas with insights from other industries or countries. We provide conditions under which each country's equilibrium frontier of knowledge converges to a Fréchet distribution, and derive a system of differential equations describing the evolution of the scale parameters of these distributions, that is, countries' stocks of knowledge. The model remains tractable with many asymmetric countries and generates a rich set of predictions about how the level and composition of trade affect countries' frontiers of knowledge. We use the framework to quantify the contribution of bilateral trade costs to long‐run changes in TFP and individual post‐war growth miracles. For our preferred calibration, we find that both gains from trade and the fraction of variation of TFP growth accounted for by changes in trade more than double relative to a model without diffusion.
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