Beyond the Hump: Structural Change in an Open Economy

This paper investigates the role of trade in driving structural change. First, I develop a decomposition that attributes change in manufacturing shares to adjustments along three margins: international sourcing decisions, sectoral expenditure shares, and aggregate trade deficits. Using a structural model, I interpret these as endogenous responses to exogenous shocks. Applying the decomposition to data from twenty economies between 1965 and 2011, I find that 40% of the observed change in manufacturing shares was due to specialization subject to comparative advantage and compositional effects arising from international borrowing. Moreover, these mechanisms were key in driving the cross-country heterogeneity and changes in the composition of aggregate manufacturing. Finally, I use counterfactual analysis to inspect two popular narratives that link trade and industrialization. My results show that the competition with China has resulted in a world-wide squeeze in manufacturing shares, and that in South Korea, trade specialization was responsible for both its rapid industrialization, and the shift towards high-technology manufacturing.