DP4964 Productivity Spillovers, Terms of Trade and the 'Home Market Effect'

Author(s): Giancarlo Corsetti, Philippe Martin, Paolo Pesenti
Publication Date: March 2005
Keyword(s): productivity, taste for variety, terms of trade, trade
JEL(s): F32, F41
Programme Areas: International Macroeconomics, International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4964

This paper analyses the welfare implications of international spillovers related to productivity gains, changes in market size, or government spending. We introduce trade costs and endogenous varieties in a two-country general-equilibrium model with monopolistic competition, drawing a distinction between productivity gains that enhance manufacturing efficiency, and gains that lower the cost of firms? entry and product differentiation. Our model suggests that countries with lower manufacturing costs have higher GDP but supply a smaller number of goods at a lower international price. Countries with lower entry and differentiation costs also have higher GDP, but supply a larger array of goods at improved terms of trade. The sign of the international welfare spillovers depends on terms of trade, but also on consumers? taste for variety. Higher domestic demand has macroeconomic implications that are similar to those of a reduction in firms? entry costs.