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Foreign Firms and the Diffusion of Knowledge

This paper constructs a model to examine the impact of foreign firms on a developing Country’s own accumulation of entrepreneurial knowledge. In the model, entrepreneurial skills are built up on the basis of productive ideas that diffuse internally (at the inside of firms) and externally (spillovers.) Openness to foreign firms enhances the aggregate exposure to ideas but also reduces the returns to investing in entrepreneurial skills. When externalities are present, openness can be welfare reducing. However, regardless of the relative importance of externalities, simple quantitative exercises suggest that the gains of openness are positive and can be large.

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