Productivity enhancing trade through local fragmentation

Abstract

Mechanisms linking trade and productivity are rarely discussed in well accepted trade-theoretic literature although such a link is critical especially for understanding how trade helps developing countries. We restructure the standard neo-classical model of trade to provide a clear mechanism that leads to productivity enhancement in the export sector. As trade in labor-abundant countries reduces the real return to capital due to Stolper-Samuelson hypothesis, entrepreneurs find it easier to establish new businesses as capital costs decline. A section of workers becomes entrepreneurs producing and supplying cheaper intermediate goods to the export sector. Expanding export sector helps such a process, whereas contracting import-competing sector does not. New entrepreneurs boost the productivity of the export sector by supplying low-cost input. Here a boost in entrepreneurship induced by a decline in capital cost increases productivity of the export sector. Thus, this paper establishes a different and novel link between trade and productivity.