Large Foreign Markets and Export-Led Growth in Developing Countries: Technical Paper 2004-10

Ufuk Demiroglu

Many economists and policymakers believe that international trade played an important role in the economic growth miracles of East Asia, but there is no consensus on the precise way trade helped. However, narrative accounts give the impression that an eminent feature of the growth miracles was a move toward producing goods that higher-income countries produced, adopting the better technologies and methods used in those countries. Those goods were not always demanded much in the domestic markets of the newly industrializing East Asian countries, because of lower aggregate income and smaller share of those goods in domestic demand. International trade gave those countries access to larger markets, which enabled their producers to adopt the better technologies even if domestic demand did not justify fixed costs. This paper presents a dynamic general equilibrium model of this role of trade. The kep assumption, as in Murphy et al. (1989), is that sectoral production functions are subject to a minimum efficient scale (beyond which they exhibit constant returns). To highlight the proposed gain from trade, the model rules out all other types of gains such as those arising from access to a larger variety of goods or from comparative advantage.