Capital intensity and welfare: traded and non-trade sector determinants

Why do some countries and regions have higher capital intensity than others? This question is at the heart of economic development analyses since capital intensity, per capita incomes and welfare are closely linked. We develop a two-sector general equilibrium model relevant to small open economies that import capital goods and produce export goods priced in world markets. The model is used to derive a taxonomy of factors that lead to differing capital intensities across countries. Aggregate capital intensity is a function of multi-factor productivity (MFP) in the traded goods sector (but not the non-traded sector), the capital share parameter for each sector, the cost of capital and the terms of trade. Total output and consumer utility are affected by the same variables and by non-traded sector MFP. The results shed light on observed capital intensity and per capita GDP differences between Australia and New Zealand.