Richard E. Baldwin (1992), “Measurable Dynamic Gains from Trade,”
Journal of Political
100(11), pp. 162-174.
Answer Key - Assignment 6 - ECON 422/822 - Fall 2008
1. Richard Baldwin incorporated the welfare gains from
international trade as described by the general
equilibrium model of trade (the PPF/Indifference curve
diagram) into the Solow model in a straightforward
Recall that the exploitation of comparative
advantage or increasing returns to scale permits an
economy to transform a given set of productive
resources into a greater value of final output.
gains from trade are, therefore, equivalent to a one-time
increase in the economy’s production function.
is a form of one-time technological progress.
Figure 1 shows that the shift in the production
function results in an immediate increase in real output
from Y* to Y’, as the stock of capital K*, combined
with the fixed labor force, becomes capable of
producing (and trading for) a greater value of output.
There are additional changes, however.
First of all, the
increase in output implies that people also have the
capacity to save more:
If they continue to save a constant proportion of income, then the saving function
shifts up proportionately to the production function, as shown in Figure 1, and the steady state stock of capital
grows from K* to K**, and, as a result, output rises gradually to Y**.
The Solow model thus shows that a
one-time rise in the production function caused by international trade leads to transitional growth as the
economy adjusts to a new steady state equilibrium. The international
economist Richard Baldwin applied
actual data to the Solow model and estimated that the eventual welfare gains from trade liberalization.
found, for example, that total growth would be 30 percent greater than the static trade effect for France and
129 percent greater than the static trade gains for Germany.
Germany’s larger gain was due to its higher
The Solow growth model shows that:
The static general equilibrium gains from
international trade raises per capita income because
specialization and trade enable the economy to transform its given productive resources into a greater value
of final output.
The trade-induced rise in the production function leads to transitional growth as the economy adjusts to a
new steady state equilibrium, thereby raising the gains from trade above those suggested by the previous two
chapter’s static models of trade.
The Solow model enhances the likely gains from international trade, but it also makes it very clear that,
if international trade only provides for a one-time gain in efficiency, then it cannot be the source of long-run
permanent economic growth. The evidence that shows that international trade and economic growth have
been closely related over long periods of time, perhaps for over 200 years.
This evidence suggests that there
must be some relationship between international trade and technological progress, the source of permanent
long-run economic growth.