Trade and Growth Revisited: Managing to Converge, Agreeing to Diverge∗

The impact of international trade on domestic growth is revisited in a model with dynamic externalities and static increasing returns to scale. The model embraces features of both classical and new growth and trade theories, allows for learning by doing, and integrates several strains of thought in a general equilibrium with two regions. In contrast to previous work, the model shows that international convergence of growth rates can occur despite the fact that the less developed region specializes in low-growth sectors. This is due to a distortion of the Ricardian or Heckscher-Ohlin-Vanek type specialization forces through monopolistic competition. Less developed regions can therefore manage to converge by participating in intraindustry trade. On the normative side, the model clarifies that repeated static gains from free trade weigh so heavily that a welfare-maximizing developing country may choose to give up modern sectors and to grow more slowly. It may agree to diverge in order to exploit the gains from trade, but it can manage to converge through participating in intraindustry trade. JEL: F43, F12, O41 If a pure trade theorist were to advise a less developed country about whether and to what extent it should open up to free trade, she would have to reconcile a large and partly contradictory array of results. Ricardian or Heckscher-OhlinVanek (HOV) models mandate trade liberalization unconditionally. Open up ∗I am grateful to my advisors Maury Obstfeld, David Romer, and Pranab Bardhan for their guidance, and to Chris Shannon, Ethan Ligon, and participants at the Development Workshop 2000, Berkeley, for many helpful comments and suggestions. Any remaining errors are mine. †[email protected] (www.econ.ucsd.edu/muendler)