1990s fostered inward foreign investment (and both had a positive impact on investment in education) while backtracking on trade reform had a negative impact on foreign investment. More-open economies also tend to be more innovative, because of greater trade in intellectual capital (a greater quantity and variety of information, ideas and technologies, sometimes but not only in the form of purchasable intellectual property associated with product and process innovations), and because greater competition spurs innovation (Aghion and Griffith 2005; Aghion and Howitt 2006) ), leading to higher _rates_ of capital accumulation and productivity growth (LumengaNeso, Olarreaga and Schiff 2005).<sup>7</sup> A growing body of industry studies, including ones based on firm-level survey data that capture the reality of firm heterogeneity, provides additional support for the theory that trade reform boosts the rate of productivity growth.<sup>8</sup> It appears moreproductive firms are innately better at exporting, so opening an economy leads to their growth and the demise of the least-productive firms (Bernard et al. 2007). That leads to better exploitation of comparative advantage in terms not only of industries but also of firms within each industry. If those more-productive firms are also foreign owned, as is clearly the case in China (Whalley 2006), then being open to FDI multiplies the gains from product trade openness. And if those foreign firms are involved in retailing, and they enter a country with suppliers whose productivity is below bestpractise, they can put pressure on those suppliers to raise their productivity (and perhaps alert them as to ways to do that). Walmart’s influence in Mexico provides one example of this force at work (Javorcik, Keller and Tybout 2006). Furthermore, if the foreign firms are supplying lower-cost services inputs into manufacturing, that can boost the productivity growth of local manufacturers using those service inputs, according to a recent study of the Czech Republic (Arnold, Javorcik and Mattoo 2006).<sup>9</sup> It need not be just the most-productive firms that engage in exporting. For lower-productivity firms, incurring the fixed costs of investing in newly opened foreign markets may be justifiable if accompanied by the larger sales volumes that come with exporting. Lower foreign tariffs will induce these firms to simultaneously export and invest in productivity (while inducing higher-productivity firms to export without more investing, as in Melitz 2003). Lileeva and Trefler (2007) model this econometrically using a heterogeneous response model. Unique 'plant-specific' tariff cuts serve as their instrument for the decision of Canadian plants to start exporting to the United States. They find that those lower-productivity Canadian plants that were induced by the tariff cuts to start exporting increased their labor productivity, engaged in more product innovation, and had high adoption rates of advanced manufacturing technologies. These new exporters also increased their domestic (Canadian) market share at the expense of non-exporters, which suggests that the labor productivity gains reflect underlying gains in total factor productivity.

In short, trade liberalization can lead not just to a larger capital stock and a one-off increase in productivity but also to higher _rates_ of capital accumulation and productivity growth in the reforming economy because of the way reform energizes entrepreneurs. For those higher growth rates to be sustained, though, there is widespread agreement that governments also need to (a) have in place effective institutions to efficiently allocate and protect property rights, (b) allow domestic

> 7 More open economies also tend to be less vulnerable to foreign shocks such as sudden stops in capital inflows, currency crashes and severe recessions (Frankel and Cavallo 2004).

> 8 For an overview of this new theory, see Helpman, Marin and Verdier (2008).

> 9 For a survey of the growth effects of opening to trade in services, see Hoekman (2006).

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