Number 1, March 2007

Globalization, Aggregate Productivity, and Inflation
W. Michael Cox
Complete Issue

Abstract
This paper investigates the effects of globalization on aggregate productivity, output growth, and inflation. I present a simple two-country, two-good, flexible exchange rate model using Fisher Ideal aggregators to examine changes in the mapping from microeconomic to macroeconomic productivity growth as nations globalize. Advances in industry-specific labor productivity are shown to have potentially a much greater passthrough to aggregate productivity, output, and prices the more open nations are to trade. Globalization raises both the level and growth rate of aggregate productivity by allowing more economywide reorganization in response to ongoing technological advances than would be optimal otherwise.

I develop a globalized version of the quantity equation of money, where inflation in the home country depends on domestic money growth and a weighted average of home and foreign GDP growth. Relative country size, consumer preferences, production technologies, and the openness of trade are the chief determinants of these weights. Calibrating the model to match certain stylized facts about the U.S. and global economies, U.S. consumer price inflation falls from roughly 3.8 percent when economies are closed to under 2 percent in the transition period, eventually settling at around 2.3 percent in free trade. Producer and consumer prices trek a common path under autarky but diverge as the world globalizes. Both home and foreign aggregate productivity growth rates increase—by 0.4 and 0.7 percentage points, respectively. Roughly 30 percent of the output weight in the determination of home inflation shifts from the home to the foreign economy—greater than might be expected from strong home bias.