Distortions and the Structure of the World Economy

We develop a model of the world economy as input-output relationships subject to distortions. The base units of our analysis are the country-sectors demanding and supplying output across and within countries. The input-output matrix is endogenous – the expenditure and consumption shares depend on prices and change with the distortions. We then derive a closed-form solution of the elasticities of each entry in the world input-output matrix to distortions. In addition, we derive simple closed-form sufficient statistics for distortions and for sectoral TFPs as the functions of directly observable sectoral input expenditure shares and the final goods consumption shares. We discuss the assumptions under which we can identify changes in distortions and TFPs, and their levels. We apply a 41 country 35 sector version of our model and compute a total of more than half a million internal distortions and TFPs and document their significant heterogeneity. The elasticity to changes in internal distortions is an order of magnitude larger than that of the external distortions.