Foreign Political Risk and Technological Change
84 Pages Posted: 27 Jan 2025
Date Written: January 26, 2025
Abstract
This paper studies how innovation reacts to foreign political risk and shapes its economic consequences. We develop a model of innovation in which foreign political shocks can disrupt the supply of traded inputs, predicting that greater sector-level political risk exposure abroad leads to increased domestic innovation efforts and endogenously lower reliance on foreign inputs. We combine data on sector-level technology development with time-varying measures of sector-level exposure to foreign political risk and report three sets of empirical findings. First, sectors with higher exposure to foreign political risk exhibit significantly greater innovative activity, both in the US and globally. Second, the response of innovation is particularly strong when the risk emanates from geopolitical adversaries, consistent with the finding that policy barriers to trade are more likely to emerge between geopolitical foes in response to a rise in political risk in either country. Third, country-sector pairs that export to more innovation-intensive destinations see a greater reduction in exports following a rise in domestic political risk. This finding suggests that endogenous technological change limits reliance on risky foreign markets and thus amplifies the negative effects of political turmoil on export performance.
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