Comparative advantage, endowment structure, and trade imbalances

Abstract

This research looks to theoretically demystify the evolutionary patterns of trade imbalances between developing countries and developed countries from a unique perspective of the comparative advantage in the factor endowment structure of developing countries. For this purpose, we construct a theoretical model to illustrate the inherent dynamics between the trade imbalance and the comparative advantage of the factor endowment structure under a two-country setting (Part I). The model results in three propositions: (1) as one country becomes more capital-intensive, its wage level increases and the cost of capital relatively decreases. (2) The shift in the comparative advantage of the factor endowment structure from labor intensiveness to capital intensiveness in a developing country leads to a shrinkage in trade imbalance for the developed country. (3) An increase in the wage levels of developing countries eradicates the degree of the trade deficits of developed economies. To test those two conclusions, we employ panel GMM comprised of 157 developing countries over the period 1992–2017 (Part II). The empirical evidence is broadly consistent with the propositions demonstrated herein. Finally, we discuss the potential policy recommendations for policy makers according to our findings that the free international trade creates a win-win outcome and we propose further research directions (Part III).