Can Vertical Specialization Explain the Growth of World Trade?

45 Pages Posted: 31 Jan 2000

See all articles by Kei-Mu Yi

Kei-Mu Yi

University of Houston - Department of Economics; Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Multiple version iconThere are 2 versions of this paper

Date Written: January 2000

Abstract

The growth in the trade share of output is one of the most important features of the world economy since World War II. The growth is generally thought to have been generated by falling tariff barriers worldwide. This thinking, however, does not square with standard static and dynamic international trade models. Because tariff barriers have decreased little since the early 1960s, these models cannot explain the growth of trade without assuming counterfactually large elasticities of substitution between domestic and foreign goods. I show that this growth can be reconciled with the relatively small declines in tariffs once vertical specialization is included in the models. Vertical specialization, which occurs when countries specialize only in particular stages of a good's production sequence, magnifies the trade growth effects of trade barrier reduction. To show this, I calibrate and simulate a dynamic Ricardian model of trade with vertical specialization. I show that this model can explain about 70 percent of the growth of trade with just a unitary elasticity of substitution. The model also has important implications for the gains from trade.

JEL Classification: F1, F4

Suggested Citation

Yi, Kei-Mu, Can Vertical Specialization Explain the Growth of World Trade? (January 2000). FRB of New York Staff Report No. 96. Available at SSRN: https://ssrn.com/abstract=203635 or http://dx.doi.org/10.2139/ssrn.203635

Kei-Mu Yi (Contact Author)

University of Houston - Department of Economics

Houston, TX 77204-5882
United States

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

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