Vertical Specialization in a Ricardian Model with a Continuum of Stages of Production

TLDR: In this paper, a simple model is described with two countries and one final good, and it is shown how the stage of specialization can be determined as an endogenous variable, and the price system and the gains from trade are discussed.

Abstract: The traditional models of the pure theory of international trade have mainly discussed specialization in final goods. That is, the entire vertical processing of a good is done in the country that specializes in that good. Thus, if a country specializes in the production of clothing, the raw materials needed for the production of clothing are also produced in that country. Vertical specialization,1 on the other hand, means that the countries specialize along the vertical productive spectrum of a good. One country may produce yarn and export it while the other country may produce clothing with imported yarn. The traded goods under vertical specialization are final goods as well as raw materials. A good, typically, has many stages along its vertical spectrum, and a country can specialize at any one of those stages. The question that immediately arises is what determines the particular stage at which the vertical spectrum is broken so that each country can specialize in one part? To put it differently, if a country is seen to be specializing in the production of yarn, there must be some reason why it does not specialize in raw cotton. The purpose of this paper is to answer that question. In Section I, a very simple model is described with two countries and one final good, and it is shown how the stage of specialization can be determined as an endogenous variable. Section II discusses the price system and the gains from trade; while Section III briefly discusses how the model can be extended to incorporate two final goods.