Research and discussions on international trade strategies and economic growth performance goes back to Adam Smith’s major contribution “Wealth of Nations”. Although there is a common belief that openness in international trade has positive contributions to economic growth, theory and testing of models entails certain economic difficulties. We face two alternative approaches in testing long-term implications of implemented policies and long run productivity increases.
Initial attempt, is known as the neoclassical growth approach, which carries traditional growth properties. In this approach, majority adopting the Solow growth model emphasizes that long-term growth process relies on exogenous technological growth rate. Although empirical studies show a positive correlation between investment and growth of Per capita income, these models display level effects but not growth effects of investment changes. Basic reason for such a finding is the existence of diminishing returns. Under constant growth rate of exogenous technology, the economy experiences the process of income growth (level effect). The neoclassical growth theory is based on the assumption that every firm or economy can take and adopt a new technology without bearing any cost. Therefore, these models cannot capture the spillover effects of technology via international flows of capital goods and knowledge. Another assumption that bother neoclassical growth model is the perfect competition. However, the main characteristic of the new growth models that produce long-run growth effect is the imperfect competition of goods and factor markets.
The second approach is based on the new developments in growth theory that known as endogenous growth models and on the imperfect competition models of international trade. In this approach theoretical literature basically deals with the technical conditions, by which the engines of long run growth is identified. In the endogenous growth models, the diminishing returns to re-producible factors of production are eliminated and/or externalities go to the fore (Romer, 1986 ve 1989; Lucas, 1988). The recent literature has distinguished between two classes of endogenous growth models. “The first class consists of ‘idea’ models such as Romer (1990), Grossman and Helpman (1991) and Aghion and Howitt (1992). In these models new products or processes (ideas) spring from R&D expenditures. The new products raise productivity once they are embodied in non-labor inputs such as higher quality or more specialized capital and intermediate goods. As Romer (1990) argues, ideas are non-rival that, they can be embodied in many units of capital and intermediate goods without duplicating upfront R&D activities. The second class of endogenous growth models consists of rival human capital models such as Jones and Manuelli (1990) and Rebelo (1991). By ‘rival’ is meant skills that accrue solely to the person investing in those skills (Klenow, 1998, 3-4)”. De Long and Summers (1992) assert that investment in machinery equipment stimulates the economic growth rate of an economy. This paper is associated with AK type endogenous growth models and spillover effect of technology by imported machinery equipment.
Bayoumi, Coe and Helpman (1999) investigated the effects of R&D efforts that spillover internationally by intermediate and capital goods trade on total factor productivity. Their model is based on a non-AK type growth model that is familiar from Romer (1990) and Rebelo (1991). Therefore, the model generates only level effect at GDP. According to the authors, foreign trade, including capital goods, stimulates learning from trade partners. The rise in foreign R&D capital that linked by import share of capital goods (SITC 7) boosts total factor productivity, investment and potential output. They conclude that evidence does not depend on whether or not trade partners come from equal weight groups. In contrast, Keller (1997) emphasized the importance of random trade partner fact. He examined the link between the shares of import in GDP and TFP levels and found out that the shares of capital goods import in GDP has a significant effect on TFP.
Eaton and Kortum (2000) develop a model in which imports of capital goods have a spreading role of technological advances. They found that barriers to free trade effecting relative price of capital equipment could account for about 25 percent of productivity differences across countries. Moreover, capital goods prices over time could explain growth in productivity in advances countries.
