Trade barriers and the relative price tradables

In this paper I quantitatively address the role of trade barriers in explaining why prices of services relative to tradables are positively correlated with levels of development across countries. I argue that trade barriers play a crucial role in shaping the cross-country pattern of specialization across many heterogenous tradable goods. The pattern of specialization feeds into cross-country productivity differences in the tradables sector and is reflected in the relative price of services. I show that the existing pattern of specialization implies that the tradables-sector productivity gap between rich and poor countries is more than 80 percent larger than it would be under free trade. In turn, removing trade barriers would eliminate 64 percent of the disparity in the relative price of services between rich and poor countries, without systematically altering the cross-country pattern of the absolute price of tradables.