number of control variables. This relationship is quite robust, persisting across different ranges of the moving window and different specifications of the model, and offers further support to the market failure hypothesis.<sup>11</sup> _<Insert Figure 2 Here>_

# **5. Conclusions and Policy Implications**

Recent research has highlighted the importance of productive diversification for developing countries: a process that may be hindered by spillovers in the discovery of new products for export. After extending this finding from domestic production data to export data, we use highly disaggregated export data to develop a measure of this insidethe-frontier innovation, and characterize its relationship to on-the-frontier innovation, productive diversification, and development. We then go on to use this discovery metric to test a highly stylized model of innovation and imitation.

According to the data and in the context of our model, imitation of first-movers may be leading to fewer cases of inside-the-frontier innovation than otherwise would be the case. Even after controlling for the quadratic relationship with GDP per capita, the amount of discoveries in past years, factor endowments, plus a plethora of additional explanatory variables, discovery has a larger response to increased profitability in countries with higher barriers to entry. While the Hausmann and Rodrik (2003a) attribute this imitation specifically to the learning of production costs which are not predictable _ex ante_ , our test makes no determination as to the importance of this particular channel. The spillover may not by from learning production costs, but instead from learning the characteristics of foreign demand (Vettas 2002), free-riding on investments to cultivate foreign demand (Bhagwati 1968, Mayer 1984), learning the redesigns needed to meet foreign safety standards (Granslandt and Markusen 2000), or some other unidentified channel.

Regardless of the particular channel, this finding suggests that there are indeed spillovers from demonstrating the viability of a new product for export. While this indicates that public support for experimentation in new sectors and activities may be warranted, it is important to note that it does not mean that increasing barriers to entry is an advisable way to increase discovery. Indeed, imitation is desirable as this is the channel through which the returns of inside-the-frontier innovation are socialized. Moreover, such barriers are directly attributed to lower levels of private sector development (World Bank 2005), and according to Hausmann and Rodrik’s (2003a) model, would lead to underspecialization of the economy, as widespread imitation leads to the efficient focusing of resources in the most profitable sectors. Indeed, imitation of profitable new export sectors increases economic efficiency, and therefore should be encouraged rather than hindered. Furthermore, supporting new production with barriers to entry protects beneficiaries from market discipline, which would be repeating the errors of import-substituting industrialization policies by not allowing the market to

> 11 A changing relationship between returns and discovery could manifest itself through changes in the other coefficients or the constant, but estimates of all other coefficients were stable across the moving window.

11