Globalization, dual economy, and economic development

Abstract

This paper applies inframarginal analysis, which is a combination of marginal and total cost-benefit analysis, to a model with both constant returns and increasing returns in production. It demonstrates that as transaction conditions are improved, the general equilibrium discontinuously jumps from autarky to partial division of labor with a dual structure, then to the complete division of labor where the dual structure disappears. Two types of dual structure may occur in the transitional stage of economic development and globalization. One of them involves the division of labor in the developed economy and autarky in the less developed economy, generating increasing disparity of per capita real income between the two types of economies. The other involves a domestic dual structure in the less developed economy, where the population is divided between a commercialized sector that trades with a foreign country and a self-sufficient sector that is not involved in trade. All gains from trade go to the developed economy. This paper shows that deterioration of a country's terms of trade and an increase of gains that this country receives from trade may concur, provided productivity progress from an expanded network of division of labor outpaces the deterioration of terms of trade. In the model with both endogenous and exogenous comparative advantages, a country may export a good with exogenous comparative disadvantage if endogenous comparative advantage dominates this exogenous comparative disadvantage. Implications of the findings for China's WTO membership and China's trade policy are explored.