Taking Stock
This section had three main ob jectives.
The first was to emphasize the shortcoming of using the closed-economy models for the analysis of the economic growth patterns across countries or regions.
In this respect, we have shown how both international trade in assets (international borrowing and lending) and 796international trade in commodities change both the dynamics and potentially long-run implications of the closed-economy neoclassical growth models. For example, international capital flows remove transitional dynamics, because economies that are short of capital do not need to accumulate it slowly, but can borrow in international markets. Naturally, there are limits to how much international borrowing can take place. Countries are sovereign entities, thus it is relatively easy for them to declare bankruptcy once they have borrowed a lot. Consequently, the sovereign borrowing risk might place limits on the ability of countries to use international markets to smooth consumption and to increase their investments rapidly. Even in this case, some amount of international lending will take place and this will have an important effect on the equilibrium dynamics of output in the capital stock. The available evidence shows that the amount of gross capital flows are very large, though the Feldstein-Horioka puzzle, that fluctuations in investment are correlated with fluctuations in savings, shows that there are limits to net international capital flows. An investigation of why, despite the very large size of the gross capital flows, net international capital flows do not play a greater role in international consumption smoothing is an interesting area for future research. While there is some research on this topic in international finance, its implications for economic growth are important and need to be studied.
We have further seen that international trade in commodities also changes the implications of the neoclassical growth model.
For example, in the model of economic growth with Heckscher-Ohlin trade in Section 19.3, trade in goods plays the same role as international lending and borrowing, and significantly changes cross-country output dynamics. Thus even in the absence of international lending and borrowing, the implications of approaches that model the entire world equilibrium are significantly different from those focusing on closed- economy dynamics. The model of economic growth with Ricardian trade in Section 19.4 also showed that output dynamics are very different in the presence of trade. In that model, there would be no convergence across countries without trade, but international trade, via the terms of trade effects it induces, creates a powerful force that links the real incomes of different countries. Consequently, the long-run equilibrium involves a stable world income distribution and the short-run dynamics are very different from the closed-economy model.The second ob jective was to highlight how the nature of international trade interacts with the process of economic growth. Sections 19.3 and 19.4 focused on this issue. The model of economic growth with Heckscher-Ohlin trade showed how economic growth increases the effective elasticity of output with respect to capital for each country, because of (conditional) factor price equalization. This is useful in understanding how certain economies, such as East Asian tigers, can grow rapidly for extended periods relying on capital accumulation without running into diminishing returns. However, our analysis also showed that a pure Heckscher- Ohlin model may not be an appropriate framework for the analysis of the interactions across countries. In contrast, the model in Section 19.4 emphasized how Ricardian trade, based on technological comparative advantage, creates a new source of diminishing returns to accumulation for each country based on terms of trade effects. As a country accumulates more capital, it starts exporting more of the goods in which it specializes.
The result is a worsening of its terms of trade, effectively reducing the rate of return to further capital accumulation. The analysis showed how this force leads to a stable world income distribution, whereby rapidly growing economies pull of the laggards together with them. How are we to reconcile the different implications of the models in Sections 19.3 and 19.4? One possibility is to imagine a world that is a mixture of the models of these two sections. It may be that some goods are “standardized” and can be produced in any country. When producing these goods, there are no terms of trade effects. So if a country can grow only by producing these goods, it can escape the standard diminishing returns to capital thanks to international trade. This might be a good approximation to the situation experienced by the East Asian tigers in the 1970s and 80s, when they specialized in medium-tech goods. However, as countries become richer they also produce and consume more specialized goods. These goods often come in differentiated varieties and thus a greater supply of any one of these goods will create terms of trade effects. Consequently, if a country is in the stage of development where it produces more of the specialized goods, further capital accumulation will run into diminishing returns through the mechanism highlighted in Section 19.4. Irrespective of how the forces emphasized in these two approaches are combined, they both show the importance of modeling the world equilibrium and also the importance of viewing the changes in the rate of return to capital in the context of the trading relations of an economy.The third ob jective of this chapter was to investigate the effect of international trade on economic growth. Here, Sections 19.6 and 19.7 illustrated two different approaches, one emphasizing the beneficial effects of trade on growth, the other one the potential negative effects. Both classes of models are useful to have in one’s arsenal in the analysis of world equilibrium and economic growth. The usefulness of these models notwithstanding, the impact of international trade of economic growth is ultimately an empirical question, though our theoretical analysis has already highlighted some important mechanisms and also suggested that the negative effects of trade on growth are unlikely to be important. Whether the positive effects of trade on technological progress are quantitatively significant remains an open question. It may well be that static gains of trade are more important than its dynamic gains. Nevertheless, any analysis of international trade must take its implications on economic growth and technological change into account.
19.9.