Trade Policy in a Ricardian World with International Knowledge Diffusion

This paper studies the optimal trade policy in the presence of international knowledge diffusion. Since importing from more productive foreign exporters facilitates knowledge diffusion, countries have strong incentives to treat their trade partners differently in trade policy. I quantitatively assess the welfare implications of trade policies in a dynamic trade model which explicitly incorporates knowledge diffusion. The quantitative exercise suggests that the impact of the GATT/WTO's ``non-discrimination'' principles on countries at different stages of development is heterogeneous and that flexibility in the MFN tariff is desirable for under-developed countries