Specific Human Capital, Trade, and the Wealth of Nations

We develop a general equilibrium model of trade with endogenous human capital acquisition in job specific skills and imperfectly observable skills. We show that even if there are no ex-ante fundamental differences between countries there may be equilibria under international trade with specialization in production and cross-country differences in standards of living. In particular, this may happen even if there is a unique equilibrium under autharchy; protectionism may in this case be a welfare enhancing policy for the poor country. In an asymmetric equilibrium, the country with a relatively skilled labor force will specialize in production of goods that are intensive in skilled labor. Incentives to invest in human capital depend on aggregate investments within the country and the relative factor prices. We show that incentives to invest in human capital are strictly decreasing in aggregate investments in the other country. Hence, our model has in common with many other approaches that externalities are central. Furthermore, as in most macro-oriented research on the topic, differences in standard of living are generated by differences in human capital accumulation. However, contrary to most previous work we provide explicit micro-foundations for the externalities: what distinguishes our model from most of the previous literature is that we assume that human capital investments are imperfectly observable. The external effects are derived from what we view as a rather natural informational problem and will as a consequence of barriers to labor mobility be local to the country where labor can move freely within.