Staff Reports
Can Vertical Specialization Explain the Growth of World Trade?
January 2000Number 96
JEL classification: F4, F1

Author: Kei-Mu Yi

The growth in the trade share of output is one of the most important features of the world economy since World War II. The growth is generally thought to have been generated by falling tariff barriers worldwide. This thinking, however, does not square with standard static and dynamic international trade models. Because tariff barriers have decreased little since the early 1960s, these models cannot explain the growth of trade without assuming counterfactually large elasticities of substitution between domestic and foreign goods. I show that this growth can be reconciled with the relatively small declines in tariffs once vertical specialization is included in the models. Vertical specialization, which occurs when countries specialize only in particular stages of a good's production sequence, magnifies the trade growth effects of trade barrier reduction. To show this, I calibrate and simulate a dynamic Ricardian model of trade with vertical specialization. I show that this model can explain about 70 percent of the growth of trade with just a unitary elasticity of substitution. The model also has important implications for the gains from trade.

Available only in PDFPDF45 pages / 2,188 kb

For a published version of the report, see Kei-Mu Yi, "Can Vertical Specialization Explain the Growth of World Trade?" Journal of Political Economy 111, no. 1 (February 2003): 52-102.

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