Vertical Specialization with Heterogeneous Entrepreneurs: Can Trade Promote Industrialization of Developing Countries?

Abstract

This paper explores the theoretical link between trade liberalization and industrial development in developing economies. A two-country, three-good, and three-factor computable general equilibrium model is developed, which features a capital-intensive intermediate good, and a special factor of production, the entrepreneurial skill. The numerical results suggest that with free trade, the developing economy can import the cheaper capital-intensive intermediate good and largely expand its manufacture sector. Moreover, the developing economy can export its manufactured product to the developed economy. Unlike the conventional static trade models that predict that developing economies will de-industrialize with free trade, this theory helps to understand the rapid industrial expansion in newly industrialized economies while liberalizing their international trade.