Trade costs, infrastructure, and dynamics in a global economy

Abstract This study develops a dynamic two‐country model with trade costs linked to international infrastructure stock. With variable markups and firm heterogeneity, the welfare impact of trade costs depends on firms' cost distribution. Governments engage in a dynamic public investment game, leading to multiple steady states. The dynamic equilibrium of the noncooperative policy game may exhibit history dependency; a small (large) initial infrastructure stock results in decreasing (increasing) infrastructure over time, leading to autarky (freer trade). Comparing these outcomes with international cooperation reveals that cooperation achieves a higher steady‐state infrastructure stock and helps avoid a “low development trap.”