Trade costs, wage difference, and endogenous growth

In this paper, we develop an endogenous growth model with two coun- tries in which the international trade of differentiated goods requires dif- ferent trade costs and equilibrium wages in the two countries. If the labor productivity in one country's agricultural sector is higher than that of the other country, the wages will also be higher. In this model, there is a case in which the small country has a higher share of manufacturing firms than the larger country, and the innovation sector locates in the small country, since the cost for production of the manufacturing sector and innovation sector is higher in the large country than in the small country. First, when trade costs are high, the share of manufacturing firms in a large country increases with a decline in trade costs. However, the share then decreases with a decline in trade costs when trade costs are low. Finally, all firms agglomerate in the small country with lower production costs. If trade costs are very high, the innovation sector will locate in the small country. If trade costs take an intermediate value, it will locate in the large country. If trade costs become very low, it will re-locate in the small country. The growth rate moves non-monotonously in a W-shaped curve when there is a reduction in trade costs. This happens because the growth rate is affected by the number of manufacturing firms and the location of the innovation sector.market size, wage differential, growth rates, innovation sector.