SMU ECONOMICS & STATISTICS WORKING PAPER SERIES Paper No. 11-2008
This paper develops an approach for quantifying the importance of different sources of comparative advantage for country welfare. To explain patterns of specialization, I present a multi-country trade model that extends Eaton and Kortum (2002) to predict industry trade ows. In this framework, comparative advantage is determined by the interaction of country and industry characteristics, with countries specializing in industries whose specific production needs they are best able to meet with their factor endowments and institutional strengths. I estimate the model parameters on a large dataset of bilateral trade ows, presenting results from both a baseline OLS approach, as well as a simulated method of moments (SMM) procedure to account for the prevalence of zero trade ows in the data. I apply the model to explore various quantitative questions, in particular how much distance, Ricardian productivity, factor endowments, and institutional conditions each matter for country welfare in the global trade equilibrium. I also illustrate the shift in industry composition and the accompanying welfare gains in policy experiments where a country raises its factor endowments or improves the quality of its institutions.