EFFECT OF A TRADE REFORM ON INFRASTRUCTURE SPENDING

This dissertation consists of two essays on the effect of a trade reform on infrastructure spending. In the first essay, I empirically study the effect of India's opening up to international trade in the early 1990's on its infrastructure spending policies. To motivate the empirical work, I develop a two period model to show how optimal spending on infrastructure is negatively related to tariffs implying that when countries open up trade, their governments should build more infrastructure. I test this hypothesis using a differences-in-differences approach, exploiting state-level variation from India's trade reform. I find that for 1% reduction in tariff, state governments increased the stock of infrastructure by 0.56%. Transport infrastructure increased three times more than non-transport infrastructure. These findings shows a benevolent behaviour of governments, resulting in a new channel of gains from trade. To understand the mechanisms behind my empirical findings, in the second essay I develop and calibrate a multi-region model of international trade, private capital accumulation, and infrastructure spending, in which each government chooses such spending to maximize their state's welfare. I find if governments choose infrastructure following the reform optimally, infrastructure would have increased by 60% on average. The actual increase, based on my empirical findings, was about 25%. Looking at categories of infrastructure, I find that government's response in transport related infrastructure was 90% of what will be optimal within this model. Counterfactual exercises show that raising aggregate infrastructure towards its optimal following the trade reform will result in state GDP to increase by 7% on average.Economics, Department o