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Endogenous Comparative Advantage, Gains From Trade and Symmetry-Breaking

  • Arpita Chatterjee

    ()

    (School of Economics, Australian School of Business, the University of New South Wales)

Similar countries often choose very di¤erent policies and specialize in very distinct industries. This paper proposes a mechanism to explain policy diversity among similar countries from an open economy perspective. I study optimal policies in a two country model when policies affect determinants of trade patterns. I show that welfare gains from trade can provide sufficient incentive for asymmetric equilibrium policies, even if the two countries have identical economic fundamentals. Any asymmetric equilibrium exhibits greater production specialization than the autarky optimum; this is the source of welfare gains. For this same reason, a more asymmetric Nash equilibrium Pareto dominates a less asymmetric one. All equilibria are asymmetric if aggregate income is sufficiently convex in policy, under suitable restrictions on technology and preferences. As an application, I consider a model where skill distribution is the determinant of trade patterns and the policy in question is education policy. When heterogeneous agents choose their skill level optimally, optimal skill function is convex in government policy. In this application, symmetry-breaking in optimal education policy requires that the education cost of agents is relatively inelastic with respect to skill.

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File URL: http://research.economics.unsw.edu.au/RePEc/papers/2014-18.pdf
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Paper provided by School of Economics, The University of New South Wales in its series Discussion Papers with number 2014-18.

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Length: 36 pages
Date of creation: Apr 2014
Date of revision:
Handle: RePEc:swe:wpaper:2014-18
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  26. repec:cup:cbooks:9780521585293 is not listed on IDEAS
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