Globalization, Returns to Accumulation and the World Distribution of Output

This paper examines the extent to which the process of globalization can explain the observed widening in the cross–country distribution of output–per–worker. On the theoretical front the model highlights why, when the labor market is subject to a holdup problem, the opening up of trade will cause an increase in the dispersion of income across countries similar to that observed in the data. The increase in dispersion in the model arises due to the emergence of a discrepancy between the private and social returns to capital accumulation that favors capital abundant countries. On the empirical front, we document the relevance of the model by examining whether growth patterns, decomposition exercises and specialization patterns support the model’s predictions. Overall we find that over 50% of the recently observed increase in income dispersion across countries can be accounted for by the mechanism exemplified by the model.