Terms of trade effects on endogenous growth rates in LDCs

Abstract

This paper presents a model in which long‐term GDP growth rates of LDCs are dependent upon world price levels. The model combines an endogenous growth framework a la Romer (1986, Journal of Political Economy, 94, pp. 1002–1037) with traditional Heckscher‐Ohlin‐Samuelson international trade, while assuming investment in capital to be financed solely by domestic savings. This relatively strong assumption is justified by the empirical observation that for most LDCs foreign investment constitutes only a very small part of gross capital formation. We find that an increase in the price of capital‐intensive goods will raise the long‐term growth rate. In other words, in this model protection of the capital‐intensive goods sector will cause higher economic growth.