What Drives Productivity Differences across Countries?

Productivity differences across countries and industries determine patterns of international trade—hence, comparative advantage. What are the main drivers of these productivity differences? We provided an answer in our article “Domestic Innovation and International Technology Diffusion as Sources of Comparative Advantage.”Santacreu, Ana Maria; and Zhu, Heting. "Domestic Innovation and International Technology Diffusion as Sources of Comparative Advantage." Federal Reserve Bank of St. Louis Review, May 30, 2018.

Production and Exports

First, we found that countries tend to export more—hence, have comparative advantage—in those industries in which they are more productive. Moreover, exports of a country increase faster in those industries that experienced larger productivity growth.

Therefore, to understand sources of comparative advantage, we need to further explore the drivers of productivity growth at the country-industry level. Unfortunately, data on country-industry productivity are limited to very few countries.

In our article, we used trade and production data to compute a measure of industry productivity. We found the following patterns:

• There was a large dispersion in relative productivity at the country and industry level.
• The U.S. appeared to be, albeit with a few exceptions, the country with the largest level of technology across all industries. Hence, we treated it as the technology frontier.
• Productivity at the country and industry level grew over time.
• Not all countries and industries were converging to the technology frontier with the same intensity.

Second, we posited that innovation and international technology diffusion are the main drivers of differences in productivity across countries and industries. We explored this hypothesis quantitatively and found that both domestic innovation and technology adoption had a positive and significant effect on productivity growth.

The effect of domestic innovation on productivity growth was less in lower-income countries than in higher-income countries. In particular, a 1 percent increase in the log of research and development spending implied an increase in productivity growth of 0.21 percent in lower-income countries and of 0.49 percent in higher-income countries.

Furthermore, the relative importance of innovation with respect to technology adoption was larger in higher-income countries than in lower-income countries.

Overall, our results indicate that domestic innovation and international technology diffusion are key determinants of country-industry productivity and, hence, sources of comparative advantage. Understanding the sources of comparative advantage in a country is important in analyzing welfare gains from trade liberalizations.

¹ Santacreu, Ana Maria; and Zhu, Heting. "Domestic Innovation and International Technology Diffusion as Sources of Comparative Advantage." Federal Reserve Bank of St. Louis Review, May 30, 2018.