We unite the theories of factor abundance and monopolistic competition to explore the general equilibrium relations between trade in producer services, economies of scale and factor markets. In our model, two final goods are produced using capital, labor, and a variety of differentiated producer services that are produced under increasing returns to scale. We analyze the implications for comparative advantage and trade in goods between two countries that differ in factor endowments and in technology of service provision. Moreover, we use the concept of the integrated world equilibrium to investigate trade in goods and services, also when services require foreign direct investments.

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Under nonhomothetic preferences developing countries are less likely to gain from multilateral trade liberalization than developed countries. This paper shows that this relative disadvantage for developing countries changes when the effects on public good provision are taken into account. The impact it has depends on the strength of their comparative advantage in export markets. We show that a strong (weak) comparative advantage in export markets mitigates (reinforces) the relative disadvantage of multilateral trade liberalization for developing countries. Moreover, in the presence of public goods provision, the relative disadvantage for developing countries with a strong comparative advantage is further mitigated when also income differences within countries are taken into account.

We study the e¤ects of preferential trade agreements (PTA) in a model where income matters for consumption patterns. We develop a three-country Ricardian trade model in which goods are ranked according to priority and where economies di¤er in their income level. The poorest (richest) country has a comparative advantage in the production of lowest-ranked (highest-ranked) goods, specializing in goods with low (high) income elasticities in demand. The medium rich country specializes in the production of the intermediate-ranked commodities. We …nd that being a nonmember of a PTA leads to a terms of trade deterioration for a poor country, and a terms of trade improvement for the high-income country. Becoming a member of a PTA also does not guarantee welfare gains for the low income country, unless it is so poor that it cannot import the higher-ranked goods that the rich country produces.Keywords: Ricardian trade model; asymmetric demand complementarities; Customs Union; income distribution. JEL classi…cation: F1We would like to thank Willy Spanjers, Peter Skott as well as participants of seminars at Kingston University, the Radboud University Nijmegen, the MWIEG Fall 2005 meeting in Lawrence, Kansas, the 2006 DEGIT XI workshop in Jerusalem, and the 2006 ETSG meeting in Vienna for their useful comments and suggestions. Finally, we thank Marcia Schafgans for her perceptive comments and moral support. All remaining errors are, of course, ours.