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Capital goods trade and economic development

  • Mutreja, Piyusha

    (Syracuse University)

  • Ravikumar, B.

    (Federal Reserve Bank of St. Louis)

  • Sposi, Michael J.

    (Federal Reserve Bank of Dallas)

Almost 80 percent of capital goods production in the world is concentrated in 10 countries. Poor countries import most of their capital goods. We argue that international trade in capital goods has quantitatively important effects on economic development through two channels: (i) capital formation and (ii) aggregate TFP. We embed a multi country, multi sector Ricardian model of trade into a neoclassical growth model. Barriers to trade result in a misallocation of factors both within and across countries. We calibrate the model to bilateral trade flows, prices, and income per worker. Our model matches several trade and development facts within a unified framework. It is consistent with the world distribution of capital goods production, cross-country differences in investment rate and price of final goods, and cross-country equalization of price of capital goods and marginal product of capital. The cross-country income differences decline by more than 50 percent when distortions to trade are eliminated, with 80 percent of the change in each country’s income attributable to change in capital. Autarky in capital goods results in an income loss of 17 percent for poor countries, with all of the loss stemming from decreased capital.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2014-12.

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Length: 45 pages
Date of creation: 16 May 2014
Date of revision:
Handle: RePEc:fip:fedlwp:2014-012
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  1. Jeremy Greenwood & Juan M. Sanchez & Cheng Wang, 2012. "Quantifying the Impact of Financial Development on Economic Development," RCER Working Papers 572, University of Rochester - Center for Economic Research (RCER).
  2. Chang-Tai Hsieh & Peter J. Klenow, 2003. "Relative prices and relative prosperity," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  3. Ina Simonovska & Michael Waugh, 2011. "The Elasticity of Trade: Estimates and Evidence," Working Papers 112, University of California, Davis, Department of Economics.
  4. Douglas Gollin, 2002. "Getting Income Shares Right," Journal of Political Economy, University of Chicago Press, vol. 110(2), pages 458-474, April.
  5. Restuccia, Diego & Urrutia, Carlos, 2001. "Relative prices and investment rates," Journal of Monetary Economics, Elsevier, vol. 47(1), pages 93-121, February.
  6. Yongseok Shin & Joe Kaboski & Francisco J. Buera, 2008. "Finance and Development: A Tale of Two Sectors," 2008 Meeting Papers 955, Society for Economic Dynamics.
  7. Piyusha Mutreja & B. Ravikumar & Raymond Riezman & Michael J. Sposi, 2012. "Price equalization does not imply free trade," Working Papers 2012-010, Federal Reserve Bank of St. Louis.
  8. Robert E. Hall & Charles I. Jones, 1999. "Why Do Some Countries Produce So Much More Output per Worker than Others?," NBER Working Papers 6564, National Bureau of Economic Research, Inc.
  9. Westphal, Larry E, 1990. "Industrial Policy in an Export-Propelled Economy: Lessons from South Korea's Experience," Journal of Economic Perspectives, American Economic Association, vol. 4(3), pages 41-59, Summer.
  10. Michael Sposi, 2013. "Trade barriers and the relative price tradables," Globalization and Monetary Policy Institute Working Paper 139, Federal Reserve Bank of Dallas.
  11. Lucas, Robert E, Jr, 1990. "Why Doesn't Capital Flow from Rich to Poor Countries?," American Economic Review, American Economic Association, vol. 80(2), pages 92-96, May.
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