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International Borrowing, Specialization, and Unemployment in a Small Open Economy

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  • Patrick N. Osakwe
  • Shouyong Shi

Abstract

The authors show that an increase in international borrowing increases specialization and unemployment in a small open economy that is subject to terms-of-trade risks. The economy has a production advantage in the export sector. However, the size of the export sector is limited by the available funds. To insure workers against income fluctuations arising from terms-of-trade risks, firms in the export sector offer workers a stable wage rate with the possibility of unemployment. An increase in international borrowing increases specialization in the export sector, which leads to higher unemployment when the terms-of-trade shock is bad. A state-contingent price subsidy can reduce unemployment without inefficiently reducing specialization. The results are robust to the introduction of risk-averse firms. Copyright Blackwell Publishing Ltd 2004.

Suggested Citation

  • Patrick N. Osakwe & Shouyong Shi, 2004. "International Borrowing, Specialization, and Unemployment in a Small Open Economy," Review of International Economics, Wiley Blackwell, vol. 12(1), pages 41-59, February.
  • Handle: RePEc:bla:reviec:v:12:y:2004:i:1:p:41-59
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    Cited by:

    1. Lafrance, Robert & Osakwe, Patrick & St-Amant, Pierre, 1998. "Evaluating Alternative Measures of the Real Effective Exchange Rate," Staff Working Papers 98-20, Bank of Canada.

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