Neoclassical Growth, Manufacturing Agglomeration, and Terms of Trade
Dieter M. Urban
Johannes Gutenberg University of Mainz - Institute for International Economic Theory; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Review of International Economics, Vol. 15, No. 5, pp. 1014-1035, November 2007
This study reverses the prediction of geography and growth models that trade integration may cause income divergence. Moreover, a new dynamic welfare gain of trade openness is identified. These results are obtained from embedding a new economic geography model into a neoclassical growth model. Starting from symmetric countries, a country that accumulates more capital than the other increases its home market size, improves its terms of trade, and lowers its relative consumption price index, because trade costs drive a wedge in between relative producer and consumption price indices. Both effects in turn tend to increase its marginal revenue product of capital relative to the other country (divergence forces), while factor substitution diminishes its marginal revenue product of capital (convergence force). Reducing trade costs decreases the wedge and weakens the divergence forces, while the convergence force is unaffected. Hence, divergence is more likely with higher rather than lower trade costs.
Number of Pages in PDF File: 22Accepted Paper Series
Date posted: October 22, 2007
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