Economic Integration and Endogenous Growth

TL;DR: In this paper, the authors consider two models with different specifications of the research and development sector that is the source of growth and show that either form of integration can increase the long-run rate of growth if it encourages the worldwide exploitation of increasing returns to scale in the R&D sector.

Abstract: In a world with two similar, developed economies, economic integration can cause a permanent increase in the worldwide rate of growth. Starting from a position of isolation, closer integration can be achieved by increasing trade in goods or by increasing flows of ideas. We consider two models with different specifications of the research and development sector that is the source of growth. Either form of integration can increase the long-run rate of growth if it encourages the worldwide exploitation of increasing returns to scale in the research and development sector. I. INTRODUCTION Many economists believe that increased economic integration between the developed economies of the world has tended to increase the long-run rate of economic growth. If they were asked to make an intuitive prediction, they would suggest that prospects for growth would be permanently diminished if a barrier were erected that impeded the flow of all goods, ideas, and people between Asia, Europe, and North America. Yet it would be difficult for any of us to offer a rigorous model that has been (or even could be) calibrated to data and that could justify this belief. We know what some of the basic elements of such a growth model would be. Historical analysis (e.g., Rosenberg [1980]) shows that the creation and transmission of ideas has been extremely important in the development of modern standards of living. Theoretical arguments dating from Adam Smith's analysis of the pin factory have emphasized the potential importance of fixed costs and the extent of the market. There is a long tradition in trade theory of using models with Marshallian external effects to approach questions about increasing returns. More recently, static models with fixed costs and international specialization have been proposed that come closer to Smith's description of the sources of the gains from trade [Dixit and Norman, 1980; Ethier, 1982; Krugman, 1979, 1981; Lancaster, 1980]. There are also dynamic models with fixed costs and differentiated products in which output