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Globalization, Increasing Returns in Component Production, and the Pattern of Trade

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  • Anu Kovarikova Arro

Abstract

This paper proposes that globalization, through the enlargement of the market, can influence both specialization and the equilibrium firm size. By re-introducing two factors of production into the muchutilized Dixit-Stiglitz-Ethier framework, I show that gains from specialization depend only on capital, while gains from increasing firm size face a trade-off between labor and capital as the size of the market expands. If the markup that the firms charge is instead endogenously determined, I demonstrate how firms can gain from both internal and external economies as globalization occurs if the number of firms stays under a specified threshold. The paper also shows that opening up to free trade in intermediate inputs and a final consumption good will have relative endowments determining the direction of trade across the stages of production. The model predicts that a relatively capital-abundant country will be the importer of the final good and the net exporter of intermediate components. Compared to autarky, trade will enhance specialization and firm size in the capital-abundant country and diminish both in the laborabundant country. Welfare can either increase or decrease as a result of trade.

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Bibliographic Info

Paper provided by The Center for Economic Research and Graduate Education - Economic Institute, Prague in its series CERGE-EI Working Papers with number wp265.

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Date of creation: Jun 2005
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Handle: RePEc:cer:papers:wp265

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Keywords: Monopolistic competition; external and internal economies of scale; trade across the stages of production.;

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  1. Simon Evenett, 2004. "The Cross-Border Mergers and Acquisitions Wave of the Late 1990s," NBER Chapters, in: Challenges to Globalization: Analyzing the Economics, pages 411-470 National Bureau of Economic Research, Inc.
  2. Raphael Bergoeing & Tim Kehoe & Vanessa Strauss-Kahn & Kei-Mu Yi, 2004. "Why is Manufacturing Trade Rising Even as Manufacturing Output is Falling?," Documentos de Trabajo 178, Centro de Economía Aplicada, Universidad de Chile.
  3. d'Aspremont, Claude & Dos Santos Ferreira, Rodolphe & Gerard-Varet, Louis-Andre, 1996. "On the Dixit-Stiglitz Model of Monopolistic Competition," American Economic Review, American Economic Association, vol. 86(3), pages 623-29, June.
  4. Gordon H. Hanson & Raymond J. Mataloni & Matthew J. Slaughter, 2005. "Vertical Production Networks in Multinational Firms," The Review of Economics and Statistics, MIT Press, vol. 87(4), pages 664-678, November.
  5. Liu, Pak-Wai & Yang, Xiaokai, 2000. "The theory of irrelevance of the size of the firm," Journal of Economic Behavior & Organization, Elsevier, vol. 42(2), pages 145-165, June.
  6. Venables, Anthony J., 1996. "Trade policy, cumulative causation, and industrial development," Journal of Development Economics, Elsevier, vol. 49(1), pages 179-197, April.
  7. Egger, Hartmut & Egger, Peter, 2001. "Cross-border sourcing and outward processing in EU manufacturing," The North American Journal of Economics and Finance, Elsevier, vol. 12(3), pages 243-256, November.
  8. Markusen, James & Rutherford, Thomas F. & Tarr, David, 2000. "Foreign direct investment in services and the domestic market for expertise," Policy Research Working Paper Series 2413, The World Bank.
  9. Yang, Xiaokai & Heijdra, Ben J, 1993. "Monopolistic Competition and Optimum Product Diversity: Comment," American Economic Review, American Economic Association, vol. 83(1), pages 295-301, March.
  10. Eckel, Carsten, 2008. "Globalization and specialization," Journal of International Economics, Elsevier, vol. 75(1), pages 219-228, May.
  11. Rivera-Batiz, Francisco L. & Rivera-Batiz, Luis A., 1990. "The effects of direct foreign investment in the presence of increasing returns due to specialization," Journal of Development Economics, Elsevier, vol. 34(1-2), pages 287-307, November.
  12. Batra, Raveendra N & Casas, Francisco R, 1973. "Intermediate Products and the Pure Theory of International Trade: A Neo-Heckscher-Ohlin Framework," American Economic Review, American Economic Association, vol. 63(3), pages 297-311, June.
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