Ricardian Comparative Advantage in the Heckscher-Ohlin Economy with Public Infrastructure

This study conducts a detailed analysis of the production possibility frontier (PPF) and fundamental trade theorems in an economy with two goods; each produced using two primary factors, and public infrastructure, which is also produced by using the two factors and has positive externalities on the production of each good. We identify conditions under which the PPF in this Heckscher-Ohlin (HO) type economy exhibits similar properties (i.e., convex to the origin as opposed to the conventional HO models) to those of the Ricardian economy in the presence of public infrastructure. We also discuss the determinant of comparative advantage in terms of the factor endowments, showing that a country endowed with larger factor endowments specialises in the good whose marginal productivity of public infrastructure is greater, and vice versa. Moreover, we analyse how trade affects factor prices and show that if the infrastructure-production sector is more capital-intensive than the private production sector, the wage rate becomes lower while the rental rate becomes higher by opening trade for a country specialised in the good whose elasticity of marginal productivity of the public input is larger, and vice versa. This means that trade liberalisation has distributional effects on each class of factor owners. Nevertheless, the aggregate welfare unambiguously improves after the opening of trade.