The Quantitative Importance of Openness in Development

FRB of St. Louis Working Paper No. 2013-025B

29 Pages Posted: 13 Sep 2013 Last revised: 20 May 2014

See all articles by Wenbiao Cai

Wenbiao Cai

University of Winnipeg - Department of Economics

B. Ravikumar

Federal Reserve Bank of Saint Louis

Raymond G. Riezman

University of Iowa - Henry B. Tippie College of Business - Department of Economics; Aarhus University - Department of Economics and Business; University of California, Santa Barbara (UCSB) - Department of Economics; GEP; CESifo (Center for Economic Studies and Ifo Institute)

Multiple version iconThere are 2 versions of this paper

Date Written: May 1, 2014

Abstract

This paper deals with a classic development question: how can the process of economic development – transition from stagnation in a traditional technology to industrialization and prosperity with a modern technology – be accelerated? Lewis (1954) and Rostow (1956) argue that the pace of industrialization is limited by the rate of capital formation which in turn is limited by the savings rate of workers close to subsistence. We argue that access to capital goods in the world market can be quantitatively important in speeding up the transition. We develop a parsimonious open-economy model where traditional and modern technologies coexist (a dual economy in the sense of Lewis (1954)). We show that a decline in the world price of capital goods in an open economy increases the rate of capital formation and speeds up the pace of industrialization relative to a closed economy that lacks access to cheaper capital goods. In the long run, the investment rate in the open economy is twice as high as in the closed economy and the per capita income is 23 percent higher.

Keywords: Openness, Industrialization, Capital formation, Relative price of investment

JEL Classification: O11, F43, O14

Suggested Citation

Cai, Wenbiao and Ravikumar, B. and Riezman, Raymond G., The Quantitative Importance of Openness in Development (May 1, 2014). FRB of St. Louis Working Paper No. 2013-025B. Available at SSRN: https://ssrn.com/abstract=2324566 or http://dx.doi.org/10.2139/ssrn.2324566

Wenbiao Cai

University of Winnipeg - Department of Economics ( email )

Winnipeg, Manitoba R3B 2E9
Canada

B. Ravikumar (Contact Author)

Federal Reserve Bank of Saint Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Raymond G. Riezman

University of Iowa - Henry B. Tippie College of Business - Department of Economics ( email )

316 PBB
Iowa City, IA 52242
United States

HOME PAGE: http://www.biz.uiowa.edu/faculty/rriezman/

Aarhus University - Department of Economics and Business ( email )

Fuglesangs Alle 4
Aarus, 8210
Denmark

HOME PAGE: http://www.biz.uiowa.edu/faculty/rriezman/

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

2127 North Hall
Santa Barbara, CA 93106
United States

GEP ( email )

University Park
Nottingham, NG7 2RD
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.cesifo.de

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