Trade, Growth, and the World Income Distribution

We construct and test a theory of how international trade and endogenous economic growth interact to affect the evolution of cross-country differences in GDP. The theory combines a second-generation endogenous growth model with a Ricardian model of trade. The driver of growth is technical progress in improving the quality of intermediate goods.. Intermediates are tradeable, and trade in them allows countries to affect each other's growth rates. The theory describes both balanced growth paths and transition dynamics. Under some conditions trade equalizes countries' growth rates and thus stabilizes their relative GDPs, under other conditions trade does not equalize growth rates initially but brings them into equality eventually, and under still other conditions trade drives countries’ growth rates asymptotically to a constant difference, leaving some countries growing faster than others forever. This last case is consistent with Quah’s (1997) famous empirical "twin peaks." The model provides a closed-form solution for transition dynamics as well as balanced growth paths. allowing a complete description of the evolution of countries’ relative GDPs. A large number of testable implications emerge from the model, some of which distinguish it from competing theories of world income distribution dynamics. Preliminary test results support our theory.