Trade Costs, Global Value Chains and Economic Development

This paper develops a model to study the impact of trade costs on developing countries' industrialization when sequential production is networked internationally in global value chains (GVCs). In a two-country setting, a decrease in trade costs of intermediates is associated with the South moving up the value chain and both North and South experiencing welfare improvement due in part to non-linear wage responses. Extending the model to a multi-country setting, I show that reduced trade frictions lead South countries to join supply-chain networks due to wage differentials and low trade costs. This increases the North wage but may decrease the wages of southern nations already part of the network. Moreover, the Southern nations that join tend to be regionally clustered, producing a Factory-Asia like outcome. The model provides a first look at GVCs from the development angle, and raises several interesting policy concerns regarding GVC governance.