Capital Accumulation and Dynamic Gains from Trade

By B. Ravikumar, Ana Maria Satacreu and Michael Sposi

http://d.repec.org/n?u=RePEc:fip:fedlwp:2017-005&r=dge

We compute welfare gains from trade in a dynamic, multicountry model with capital accumulation. We examine transition paths for 93 countries following a permanent, uniform, unanticipated trade liberalization. Both the relative price of investment and the investment rate respond to changes in trade frictions. Relative to a static model, the dynamic welfare gains in a model with balanced trade are three times as large. The gains including transition are 60 percent of those computed by comparing only steady states. Trade imbalances have negligible effects on the cross-country distribution of dynamic gains. However, relative to the balanced-trade model, small, less-developed countries accrue the gains faster in a model with trade imbalances by running trade deficits in the short run but have lower consumption in the long-run. In both models, most of the dynamic gains are driven by capital accumulation.

Nobody should be surprised that removing trade frictions increases trade, and that this leads to welfare gains. And neither should it surprise you that taking into account the dynamic effects through capital accumulation may amplify these results. But that the amplification is that big is a big deal, even more in the current policy context.