Monday, February 18, 2008

Globalization and Divergence

The gap between the rich and poor nations has widened over the past two centuries, rather than narrowed as neoclassical growth theory (e.g. the Solow model) predicts. At Vox EU, Oded Galor and Andrew Mountford offer a hypothesis to explain this "great divergence":
[W]e suggest that international trade has played a significant role in the differential timing and pace of the demographic transitions across countries and has been a major determinant of the distribution of world population as well as the 'Great Divergence' in income per capita across countries. International trade has an asymmetrical effect on the evolution of industrial and non-industrial economies: While in the industrial nations the gains from trade have been directed primarily towards investment in education and growth in output per capita, a greater portion of the gains from trade in non-industrial nations has been channelled towards population growth...

The expansion of international trade has enhanced the specialisation of industrial economies in the production of industrial, skilled intensive, goods. The associated rise in the demand for skilled labour has induced a gradual investment in the quality of the population, expediting a demographic transition, stimulating technological progress and further enhancing the comparative advantage of these industrial economies in the production of skilled intensive goods. In non-industrial economies, in contrast, international trade has generated an incentive to specialise in the production of unskilled intensive, non-industrial, goods. The absence of significant demand for human capital has provided limited incentives to invest in the quality of the population and the gains from trade have been utilised primarily for a further increase in the size of the population, rather than the income of the existing population. The demographic transition in these non-industrial economies has been significantly delayed, increasing further their relative abundance of unskilled labour, enhancing their comparative disadvantage in the production of skilled intensive goods and delaying their process of development. This implies that international trade has persistently affected the distribution of population, skills, and technologies in the world economy, and has been a significant force behind the 'Great Divergence' in income per capita across countries...

The "demographic transition" they refer to is the reduction in fertility rates that tends to occur as countries develop. In contrast to neoclassical models, their hypothesis implies that investment in human capital and population growth be treated as endogenous variables - i.e. determined within the model, rather than taken as exogenously given.

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