Trade and Technology Compatibility in General Equilibrium

We develop a model of endogenous production networks in which the horizontal proximity between a firm’s technology and the technology of its suppliers affects the input cost. Firms choose their technology balancing the benefit of moving in the technological space toward suppliers with the cost of moving away from the technology they know the best. By altering the relative costs of suppliers from different countries, trade policies shape technology choices, which in turn affect trade patterns and welfare. We parameterize the model to match the relationship between trade patterns and technology proximity that we construct from patent data. We use the model to assess the role of trade in shaping firms’ technology choices in the global economy and to quantify the barriers to trade arising from technology incompatibility. Finally, we examine the welfare cost of the trade conflict between the U.S. and China in the semiconductor industry. We find that an embargo on semiconductor exports to China leads to a de-coupling in the technologies of the two countries and a re-alignment of the technologies of the rest, amplifying the welfare costs for both the U.S. and China.