revised version published in: Berkeley Electronic Journal in Macroeconomics: Contributions to Macroeconomics, 2007, 7(1), Article 5
Defensive innovations in developed countries can explain the empirical phenomenon that
openness towards trade with less-developed countries does not necessarily induce a
substantial increase in the wage differential and trade volumes. Building on step-by-step
innovations as introduced by Aghion et al. (2001), we show that defensive innovations can
result from private incentives. In particular, minimum wages can induce defensive innovations
which then redistribute income away from workers. Suggestive empirical evidence is
consistent with the implications of defensive innovations for wage differentials, trade volumes
and the sectorial composition within and across OECD countries.
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