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Why doesn't Luxembourg export all its capital to India

  • Bart Taub
  • Rui Zhao

    ()

    (University of Illinois Urbana-Champaign)

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    We explore the relationship between capital accumulation, trade, and the development of property rights. In our analysis, the development of property rights is an endogenous process, driven by capital accumulation. Property rights are defined as institutions that internalize the portion of the return to capital that is otherwise treated as common property. Instituting property rights requires a multilateral agreement among agents to carry out this internalization. It can only be sustained when agents are sufficiently patient, so that the long-run benefits of sustaining agreements outweigh the short-run incentive to defect. In this model, the agents that enters the multilateral agreement are firms, whose patience is determined by the marginal product of capital. As capital grows, the marginal product of capital shrinks, and consequently patience increases. Hence property rights can be established only when capital is sufficiently abundant. Suppose there is a capital poor country, which we will label the domestic ($D$) economy, and a capital rich economy, which we label the foreign ($F$) economy. Each country has a property rights regime in place. Our focus will be on the situation in which the capital rich country has grown sufficiently so that there is enough patience to support strong property rights. At the same time, the poor country has not attained strong property rights. Our central question is the following: would the two countries consider opening to trade? If so, how would trade affect the property rights and growth in both countries?

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    Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 843.

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    Date of creation: 03 Dec 2006
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    Handle: RePEc:red:sed006:843
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