# **I. Introduction**

Over the past three decades, globalization has been rapidly intensifying, generating opportunities for firms in many countries to enter new markets. The growth of international trade and the expansion of global value chains (GVCs) have proved to be a powerful means of economic development. Incomes and productivity have increased, while poverty has fallen in many developing countries (World Bank, 2020). Opening up the global economy and the fragmentation of production have been instrumental in enabling them to develop comparative advantages in the manufacture of certain products. This has been facilitated by trade liberalization and declining trade costs, especially after the 1980s.

More recently, the COVID-19 crisis has disrupted economic activity across the globe. In particular, global merchandise trade fell by 7% in 2020. The pandemic forced governments to impose strict containment measures, generating international supply and demand shocks across many countries (Baldwin, 2020). While GVCs have remained quite resilient to date, it is an open question whether COVID-19 will have a long-term impact on international trade and the organization of GVCs.

International trade is a key determinant of firms’ competitiveness and innovation. Trade participation, profitability and survival are driven by different aspects of the business environment in which firms operate. These include the export capacity of domestic firms in an industry, foreign direct investment (FDI), trade costs and barriers, the quality of infrastructure and the availability (or migration) of skilled workers. Trade integration also plays a critical role in shaping the incentives for firms to innovate through various channels, including larger market size, increased competition, induced specialization and international knowledge spillovers (Melitz and Redding, 2021; Buera and Oberfield, 2020; De Loecker, 2013; Gorodnichenko et al, 2010).

In this paper, we examine trade participation and innovation activities and how they are intertwined in MENA. Using cross-sectional and panel data on more than 6,000 private firms in six MENA economies (the Arab Republic of Egypt, Jordan, Lebanon, Morocco, Tunisia and the West Bank and Gaza), we explore i) structural determinants of trade participation and innovation activities before the COVID-19 outbreak; and ii) the responses of traders and innovators and their performance during the COVID-19 crisis. While the level of trade participation of firms in the MENA region is similar to other lower-middle income (LMI) and upper-middle income (UMI) economies, we show that innovation rates are particularly low. This lack of innovation, which has been deteriorating in recent years, is also reflected in the low level of investment in intangible assets. This paper does not solve the difficult puzzle of why innovation is low in MENA. Instead, it attempts to identify the characteristics of firms that participate in trade and invest in innovation and how they benefit from these activities.

On the one hand, firms that trade in international markets tend to innovate more. Moreover, we find that traders tend to grow faster when they also invest in innovation, confirming the self-selection hypothesis of more productive, larger and innovative firms into trade activities. On the other hand, trade participation impacts positively the innovation process, even after controlling for the potential sample selection bias, confirming the learning by exporting effect. In addition, the use of a foreignlicensed technology company appears to have a key role for innovation, even after controlling for the effect of trade participation.

We also find significant differences in the average size and productivity levels between traders and non-traders. In particular, compared to non-traders, we find evidence of large productivity and firm 2