Capital Accumulation and Welfare Gains from Trade

We compute welfare gains from trade in a dynamic multicountry Ricardian model where international trade affects the factors of production in each period. Our environment is a version of Eaton and Kortum (2002) embedded into a two-sector neoclassical growth model. International trade affects investment and, hence capital stock in each period. We calibrate the model and conduct two counterfactual experiments: (i) an unanticipated move to a world with frictionless trade and (ii) an unanticipated move to a world with the calibrated level of U.S. trade barriers. Our computation of the welfare gains uses levels of endogenous variables along the transition path and does not rely on just percentage changes (the hat algebra). In both experiments, (a) about 60 percent of the gains from the baseline steady state to the new steady state is achieved along the transition path and (b) countries that have lower GDP or higher barriers in the baseline experience the largest gains from trade liberalization.