Comparative advantage, end-use, and the gains from trade

Domestic expenditure share, a sufficient statistic for welfare calculations across a wide class of trade models, varies considerably by end use (intermediate or final). I show analytically that failure to account for this heterogeneity in a one-sector, one-factor model leads to systematic understatement of the gains from trade. I also show that the gains from trade are more responsive to changes in the intermediate domestic expenditure share for typical labor shares in gross output, and more responsive than the standard model suggests for typical intermediate and final domestic expenditure shares. Given the differential returns to openness in intermediate and final goods, I investigate the sources of comparative advantage that contribute to variation in expenditure shares by constructing a multi-sector, multi-factor Eaton and Kortum (2002)-style model with input-output linkages that incorporates variation in end use. I estimate the model using data for 40 countries and 34 manufacturing and service industries from the newly available World Input-Output Database. I find that lower income countries have a comparative disadvantage in the production of intermediate relative to final goods compared to higher income countries, and that the price of intermediate relative to final goods is higher in lower income countries. Higher relative prices of intermediates in lower income countries are consistent with these countries sourcing a relatively larger share of intermediates domestically, which adversely affects their gains from trade. I then solve the model using the estimated parameters to quantify the contribution of variation in comparative advantage by end use to the gains from trade.