Capital goods trade and economic development

Almost 80 percent of capital goods production in the world is concentrated in 9 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 framework. 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 the world distribution of capital goods production and accounts for almost all of the log variance in capital per worker across countries. Trade barriers in our model imply that poor countries produce too much capital goods, while rich countries produce too little, relative to the optimal allocation. The cross-country income differences fall by over 50 percent when distortions to capital goods trade are removed. Autarky in capital goods results in a 6 percent reduction in world GDP, with all of the loss stemming from decreased capital accumulation.