International trade literature tends to focus heavily on the production side of general equilibrium, leaving us with a number of empirical puzzles. There is, for example, considerably less world trade than predicted by Heckscher-Ohlin-Vanek (HOV) models. Trade among rich countries is higher and trade between rich and poor countries lower than suggested by HOV and other supply-driven theories, and trade-to-GDP ratios are higher in rich countries. Our approach focuses on the relationship between characteristics of goods and services in production and characteristics of preferences. In particular, we find a strong and significant positive correlation of more than 45% between a good’s skilled-labor intensity and its income elasticity, even when accounting for trade costs and cross-country price differences. Exploring the implications of this correlation for empirical trade puzzles, we find that it can reduce HOV’s overprediction of the variance of the net factor content of trade relative to that in the data by about 60%. Since rich countries are relatively skilled-labor abundant, they are relatively specialized in consuming the same goods and services that they are specialized in producing, and so trade more with one another than with poor countries. We also find a positive sector-level correlation between income elasticity and a sector’s tradability, which helps explain the higher trade-to-GDP ratios in high-income relative to low-income countries.

With public consumption goods, Pareto optimality can be achieved in equilibrium through Lindahl pricing. This requires that each consumer pays a price proportional to his marginal utility from the public good. The marginal cost of providing the good is then equated to the sum of the marginal benefits. Some public goods serve as inputs into production processes rather than as consumption goods: the lighthouse is an example. Efficiency in an economy with public intermediate goods requires that the marginal cost of providing them equals the sum of their marginal benefits to firms. By analogy with the case of public consumption goods, it might seem that Lindahl pricing can be extended to public intermediate goods, by requiring that firms pay in proportion to the marginal contribution of these goods to profits. Agnar Sandmo (1972) explicitly proposes this for convex technologies. For nonconvex technologies that arise with an important class of production functions (essentially those exhibiting atmosphere externalities, in the phrase of James Meade, 1952), Lindahl pricing for such public inputs is infeasible. The principal result derived here is a sim

Since the work of Robert M. Solow (1957), it has been known that technological change accounts for a significant portion of GNP growth in industrialized economies. This technological change has been measured either by the estimated time trend in regressions of aggregate output on inputs or by indexes of total factor productivity. Since under either method productivity is measured as a residual, it incorporates all factors that influence GNP growth other than the increase in measured inputs. Despite various refinements to the measurement of total factor productivity, there still is no convincing explanation for its source (see Dale W. Jorgenson and Zvi Griliches, 1967; Solow, 1988). Recent literature has suggested a potential source of productivity gains: the creation of new inputs under monopolistic competition. Wilfred Ethier (1982) has argued that the development of new intermediate inputs leads to greater specialization in the use of resources and to higher productivity (see also Markusen, 1989). Subsequent authors, including Paul M. Romer (1990) and Gene Grossman and Elhanan Helpman (1991), have examined models in which continuous growth is made possible by the creation of new inputs. Romer (1987) has considered the form of the aggregate production function in such an economy and has argued that conventional growth accounting, assuming constant returns to scale, may be incorrect. In this paper we shall examine how to account for growth when new inputs are being created. In particular, we are interested in obtaining a decomposition of growth into that due to a higher quantity of existing inputs, and that due to a greater range of inputs. In Section I, we show how this decomposition can be obtained for a constantelasticity-of-substitution (CES) production function, obtaining an exact quantity index in the presence of new inputs. In Section II we examine the CES cost function, and show how an implicit quantity index is constructed. In Section III we consider an empirical application to the productivity growth of industries within the major business groups (chaebol) of South Korea. We find that productivity is significantly correlated with the entry of new input-producing firms into the chaebol, as expected from our theoretical results.

Estimating the Knowledge-Capital Model of the Multinational Enterprise: Reply by David L. Carr, James R. Markusen and Keith E. Maskus. Published in volume 93, issue 3, pages 995-1001 of American Economic Review, June 2003

Estimating the Knowledge-Capital Model of the Multinational Enterprise by David L. Carr, James R. Markusen and Keith E. Maskus. Published in volume 91, issue 3, pages 693-708 of American Economic Review, June 2001