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Protecting Losers: Optimal Diversification, Insurance, and Trade Policy

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  • S. Lael Brainard

Abstract

This paper derives a portfolio diversification rationale for a trade policy regime that insures returns to nondiversifiable human capital investment. In the absence of complete insurance markets for human capital, the decentralized equilibrium is characterized by excessive specialization. The socially optimal investment portfolio entails diversification for the reasons familiar from the CAPM. By credibly promising to protect losers ex post, the government can achieve the optimally diversified investment pattern. In contrast to previous results, two instruments are sufficient to achieve both efficient reallocation and full insurance when human capital is mobile at some cost, due to the endogeneity of the initial investment decision.

Suggested Citation

  • S. Lael Brainard, 1991. "Protecting Losers: Optimal Diversification, Insurance, and Trade Policy," NBER Working Papers 3773, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3773
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    Cited by:

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    2. Di Maio, Michele, 2008. "Uncertainty, trade integration and the optimal level of protection in a Ricardian model with a continuum of goods," Structural Change and Economic Dynamics, Elsevier, vol. 19(4), pages 315-329, December.
    3. James A. Yunker & Alla A. Melkumian, 2012. "Opportunity Costs of Sub-Optimal Diversification," Accounting and Finance Research, Sciedu Press, vol. 1(2), pages 1-25, November.
    4. James Gaisford & Olena Ivus, 2014. "Should Smaller Countries Be More Protectionist? The Diversification Motive for Tariffs," Review of International Economics, Wiley Blackwell, vol. 22(4), pages 845-862, September.
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