Trade Capital, Human Capital and Economic Development

This paper examines a dynamic, Ricardian model of a small, open economy in which trade growth occurs endogenously as the trade capital stock rises. Trade capital grows as firms devote resources to investment in knowledge or relationships which reduces future trade costs. Because of diminishing returns to the impact of trade capital on trade costs, the steady state trade capital stock is constant. The steady state stock is an increasing function of the productivity of investment in trade capital and in a country's distance to the international market and is a decreasing function of its tariff rate. On the transitional path to the steady state, the trade capital stock rises at a decreasing rate as investment in trade capital falls. Because the share of trade in GDP is increasing in the trade capital stock, this implies conditional convergence in trade shares. External trade capital spillovers are also considered, and the results suggest that policies such as trade missions which subsidize trade capital may be welfare improving. If investment in human capital is positive, the steady state trade capital stock is shown to be a negative function of the productivity of investment in human capital. This means that the relationship between the steady state trade share and the growth rate of output is negative. As economies converge to the steady state, investment in human capital rises and the growth rate of output can rise or fall. Therefore, for economies on the transitional path, the relationship between the trade share and growth rate of human capital is positive, but the relationship between the growth rate of output and the trade share is ambiguous.