Openness To Trade as a Determinant of the Elasticity of Substitution between Capital and Labor
Some recent work on economic growth considers the aggregate elasticity of substitution between capital and labor as a measure of economic flexibility. It is thought to depend on technological and institutional determinants. I study how a openness to trade affects the aggregate elasticity of substitution of a large country in a Heckscher-Ohlin model with trade in intermediates and equalization of factor prices. With constant capital stocks, trade enlarges the set of available intermediates in the same way as a rise in the elasticity of substitution in their production would. An optimal tariff corresponds to an additional rise in the elasticity of substitution. In two growing economies, trade only rises the elasticity of substitution of the GDP function of the faster growing country.
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