Trade and Growth in a Two-Country Model with Home Production and Uneven Technological Spillovers

We develop a two-country growth model distinguishing between a market sector producing services that can also be home produced and a market sector producing goods without home-produced substitutes. The former is a technologically ‘stagnant’ sector, while the latter is subject to learning-by-doing and technological spillovers. This distinction coincides in the model with the distinction between the sector producing non-tradables and the sector producing internationally tradable goods. We study how differentials in labor tax rates across countries influence the mix of tradable and non-tradable goods that characterizes the market output of each country, thus affecting their bilateral trade balance and growth rates.