International Trade with a Public Intermediate Good and the Gains from Trade

This paper presents a one-primary factor, two-consumer good, and two-country model of international trade where each country's government supplies a country-specific public intermediate good so as to attain efficient production. By introducing the Marshallian adjustment process, it is demonstrated that the country with larger factor endowment exports the good whose productivity is more sensitive to the public intermediate good. Our normative analysis of free trade shows the following results. First, at least one country gains from trade. Secondly, if a country incompletely specializes in the trading equilibrium, the country necessarily loses from trade.