Capital Goods Trade and Economic Development

Abstract

Almost 80 percent of capital goods production in the world is concentrated in 10 countries. Poor countries import most of their capital goods. We argue that international trade in capital goods has quantitatively important effects on economic development through two channels: (i) capital formation and (ii) aggregate TFP. We embed a multi country, multi sector Ricardian model of trade into a neoclassical growth model. Barriers to trade result in a misallocation of factors both within and across countries. We calibrate the model to bilateral trade flows, prices, and income per worker. Our model matches several trade and development facts within a unified framework. It is consistent with the world distribution of capital goods production, cross-country differences in investment rate and price of final goods, and cross-country equalization of price of capital goods and marginal product of capital. The cross-country income differences decline by more than 50 percent when distortions to trade are eliminated, with 80 percent of the change in each country’s income attributable to change in capital. Autarky in capital goods results in an income loss of 17 percent for poor countries, with all of the loss stemming from decreased capital.

Keywords: Income differences; Capital goods trade; Investment rate; TFP

JEL Classification: O11, O4, F11, E22