External Economies and Trade: An Empirical Analysis

Abstract

In recent international trade literature, external economies are taking center stage as a determinant of comparative advantage in manufacturing industries. Several recent trade models have focused on learning or human capital development as the primary source of external economies. A. Young develops a model of dynamic comparative advantage with external economies at the industry level based on learning curves.' R. E. Lucas and N. L. Stokey both focus on external effects of human capital accumulation at the societal level as an engine of growth and examine the trade and development implications.2 Conducting empirical studies on models involving external effects of human capital poses the challenge of how to quantify such effects. Lucas suggests that the solution to this problem may be found by examining the urbanization economies inherent in cities.3 Lucas is not alone in drawing a parallel between urban-rural trade and international trade. P. R. Krugman exhorts trade economists to study local and regional trade as a guide to international specialization.4 Like Lucas, Krugman points to the possibilities of solving data problems: If we want to understand international specialization, a good place to start is with local specialization. The data will be better and pose fewer problems of compatibility, and the underlying economic forces will be less distorted by government policies.5 This study tests the ability of urban production data to explain international trade between the United States and developing countries. A factor proportions model with external economies is used to explain trade patterns. I use U.S. urban production data to measure the effect of differences in endowments of the factors generating external economies. The model performs well. The interesting result is the strength of the external factors, as measured by the urban production variable, in explaining international trade. This result supports Lucas's