An important prediction in international trade theories is that innovation could improve countries’

export performance. The first strand of the literature predicts that innovation can introduce new
products to the market or expand the range of products that a country exports (Krugman, 1979; Dollar,
1986; Grossman and Helpman, 1989). These studies emphasise the role of innovation in raising the
extensive margin of exports. The second strand of the literature stresses that innovation can improve
product quality (Flam and Helpman, 1987; Grossman and Helpman, 1991a) or increase productivity
(Eaton and Kortum, 2001, 2002). Innovation enhances countries’ competitiveness and leads to a higher
export value of each product, which increases the intensive margin of exports

Increases in the extensive and intensive margins have different welfare implications. If innovation
expands the range of products that countries can produce and export, the effect on welfare is positive to
the innovators. On the contrary, the welfare effect of an increase in the intensive margin depends on
whether it is driven by demand (quality) or production (costs). The estimates of this paper show that
more innovative countries export more different products and export each product at a greater quantity
and a higher unit price. This indicates that the higher intensive margin is driven by the demand side
induced by quality improvement. The empirical evidence supports that innovation has a positive effect
on welfare of the innovating countries

First, Krugman (1979) and Flam and Helpman (1987) show that technological progress imposes
asymmetric impacts on developed and developing countries. I include the interaction between patent
counts and GDP per capita to explore if innovation effects differ with a country’s income level. I find that
the impact of innovation and the relative contribution of the extensive margin are greater in low-income
countries than in high-income countries. The estimates suggest that innovation is an important factor of
developing countries’ technological catch-up. Second, the effect of innovation on exports differs across
product types. Using Rauch’s (1999) classification of differentiated and homogenous products to
categorise industries, the estimates show that innovation has a stronger effect on exports in industries
that have more differentiated products, such as instruments, electronics and transportation equipment.

Export growth can come from two sources. Exports can increase due to, new goods exported or new
countries destined as export markets or a combination of these, which is extensive margin. On the other
hand, export growth can come from increasing exports of existing firms, goods and markets, which is
referred as the intensive margin. Policymakers prefer export growth coming from the extensive margin in
order to avoid possible risks on growth path from export prices or change in the composition of world
import demand.
There is not a consensus on the sources of higher exports in trade literature.4 The Armington model
assumes that all countries produce and export a single variety (Armington, 1969). Hence, exports can
grow only by exporting more of the single export good, i.e. the intensive margin. On the other hand, the
Krugman model assumes endogenous number of export varieties which is proportional to per capita
GDP of the countries (Krugman, 1981). In addition, all countries export the same quantity per variety. As
a result, all export growth comes from the extensive margin. The Melitz model with heterogeneous firms
and fixed cost of exporting finds that only productive firms will export (Melitz, 2003). As firms become
more productive, more firms will enter the export market. Hence, Melitz model has a room for extensive
margin in export growth.

In recent years, there is a considerable literature on measuring the contributions of these margins and
relating them to some economic variables. Building on Melitz's model with heterogeneous firms,
Helpman et al. (2008) and Chaney (2008), among others, developed trade models that explicitly consider
the decision to export and therefore explicitly model the extensive margin of trade. Felbermayr and
Kohler (2006) find that GATT- or WTO-membership increases world trade via extensive margin. Markusen
(2013) extends the gains from trade literature by including the gains via extensive margin explicitly.
Brenton and Newfarmer (2007) examine the export performance of a list of developing countries and
find that growth at the extensive margin has relatively little weight in export growth, while extensive
margins in markets is higher than the one in products. Hummels and Klenow (2005) analyze a cross
section of countries in 1995 and conclude that differences in exports between larger and smaller
economies mainly come from the extensive margin. In this framework, export growth comes from the
extensive margin if the share of country's basket of export goods in world's exports is increasing. Kehoe
and Ruhl (2013) analyze several countries and arguethat extensive margin is the leading factor in export
growth of developing countries while there is no such observation for developed countries.
Furthermore, they find that structural reforms and trade agreements have significant effects on the
extensive margins whereas business cycles do not have such an effect. In country basis works, Amiti and
Freund (2010) and Bingzhan (2011) decompose Chinese export growth and Berthelon (2011) decompose
Chilean export growth into margins. Studies based on firm level data also use similar decomposition,
such as Eaton et al. (2007) for Colombian firms.

In fact, we observe that the literature has expanded and has been developed together with
methodological discussions. The analysis has been conducted in different methods for measuring
margins and used alternative dimensions, which possibly explain the changing/conflicted findings. One
method is directly decomposing export growth due to existing, new and disappearing goods, where the
contribution of existing goods are defined as intensive margin and the contribution of others are defined
as extensive margin. Amiti and Freund (2010) and Berthelon (2011) use this method. Brenton and
Newfarmer (2007) use a similar methodology for a list of developing countries but they extend the
analysis to product-country space. Eaton et al. (2007) also apply a similar decomposition in their studies
based on firm level data.

Another methodology to measure extensive margin is based on the literature on the variety of goods in
trade, starting with Feenstra (1994). Hummels and Klenow (2005) adjust Feenstra (1994)'s product
variety definition in order to get extensive and intensive margin definitions. They define extensive
margin as the ratio of total worldwide exports of a country's export basket to the total worldwide
exports and intensive margin as the share of a country's exports to the worldwide exports in the
country's export basket.

Kehoe and Ruhl (2013) criticize the definition of new good as the goods that were not exported at all in
the beginning of the analysis period. Instead, they argue that goods that are exported with very small
amounts should not be considered as export goods. They introduce the evolution of the exports of
initially least traded goods as an indicator of extensive margin. They argue that such an indicator might
capture the effect of structural changes or trade agreements on the evolution of the extensive margin.

Besedes and Prusa (2011) criticize the decomposition methodologies that use a static framework and
compare two points in time. Static approaches define the goods that are exported at the end of the
sample period but not exported at the beginning, as new goods. This way of defining ignores the
dynamics between these two points. Indeed, some of the new goods would be considered as traditional
export goods or some traditional export goods would be considered as new goods if sample period
changes slightly. They propose an alternative way of decomposing export growth which takes the
survival rate of export relationship into account. In addition, Besedes and Prusa (2011), like Evenett and
Venables (2002), use the broadest definition of extensive margin by usingproduct-country export lines as
unit of analysis. In this definition, exports of traditional products to new markets or new products to
traditional export markets are considered to be extensive margin
Export diversification is nothing but change in country's export composition and structure which can be
achieved either by making changes in the existing export commodities pattern or by expanding
innovation and technology on them (Dennis and Shepherd, 2009). The phenomenon of export
diversification has been considered as significant tool to accelerate the rate of economic growth in
developing economies. Earlier theories of international trade proposed by Adam Smith, Ricardo, neo
classical economics and model of international trade Heckscher, Ohlin and Samuelson stressed on export
specialization was criticized by Prebisch-Singer hypothesis by arguing that export specialization raises the
dependence of developing countries on the exporting of raw materials and agriculture products and
import of consumer and manufacturing products from developed countries. Literature has given the
evidences that through diversification of export basket, the risk of commodity shocks, price instabilities,
and term of trade can be reduced and the rate of economic growth can further be accelerated. The
choice between export diversification or export specialization for economic growth of developing
economies has been a debatable issue. Heckscher-Ohlin theory stressed on the fact that an economy
must specialize in the production and export of those products with respect to which it enjoys
comparative advantage due to difference in their factor intensities (Salvatore, 2009). The model was
primarily focused on the link between factor endowment and pattern of product trade and the impact of
free trade on factor distribution of income in the countries. It further states that countries should focus
on the export of those commodities in the production of which they require that factor of production
which is available in relative abundance. In this context, Prebisch-Singer hypothesis argue in favor of
export diversification because export specialization will encourage dependence of developing countries.
Furthermore, the imitation lag hypothesis (Posner, 1961) revealed the lag in technology available to
nations which create difference on trade capabilities, hence challenges the Heckscher–Ohlin model on
the pretext of uniform technology. Even the consumption of new products is not equally distributed
across the countries which encourage these countries to imitate technology. So, innovation, the only
solution left with these countries to succeed in export. The very idea is also supported by product life
cycle (PLC) theory by maintaining that growth of the economy depends upon the export diversification
and it can be increased only with continuous research and innovation of new products. Furthermore,
theory maintains that the product has to pass through three distinct stages; new product stage, maturing
stage, and standardized stage. No foreign trade takes place in new product stage as demand for new
product is only restricted to domestic market and firms even want to be with domestic consumers to
know the reaction about the new product (Ederington & Mc Calman, 2009). It is the maturing stage in
which the demand for the new product starts from foreign markets and the producer starts producing
for the foreign markets whereas production starts shifting to the developing economies in the
standardized stage and foreign trade starts expanding (Audretsch, Sanders & Zhang, 2017). Recent
growth models theories (Aghion, Akcigit & Howitt, 2014, Aghion & Howitt, 1998; Grossman and
Helpman, 1991) have given the theoretical affirmation of export diversification and these theories
maintained that increase in export diversification has positive impact on the economy's human capital
accumulation. These new growth models are related explicitly with the production of knowledge or R&D.
New growth models also argue that the access of foreign inputs augur productivity and reduce
innovation cost resulting in the product diversification. Present study aimed to survey the literature on
export diversification, economic growth, and export instability.