Capital heterogeneity as a source of comparative advantage: Putty-clay technology in a ricardian model

Abstract

This paper considers how heterogeneity in capital goods affects international trade patterns, and shows a novel source of comparative advantage: the magnitude of heterogeneity in capital goods. Capital goods are heterogeneous in their vintage and productivity, and due to capacity constraints, only productive capital goods are activated in the equilibrium. Through this selection, the distribution of capital goods determines industry-level productivity: industry-level productivity is higher in an industry with relatively larger variation in capital goods. Hence in a perfectly competitive two-country, two-good, two-factor equilibrium, the industry has Ricardian comparative advantage. An extension of the model, which includes fixed trade cost, describes a sorting situation in which the most productive production units (which are generally newer vintage) export, the moderately productive units serve the domestic market, and the least productive units (older) do not operate.