Endogenous Comparative Advantage, Gains From Trade and Symmetry-Breaking

36 Pages Posted: 1 Apr 2014

See all articles by Arpita Chatterjee

Arpita Chatterjee

UNSW Australia Business School, School of Economics

Date Written: November 1, 2013

Abstract

Similar countries often choose very different 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.

Keywords: Symmetry-breaking, Endogenous comparative advantage, Gains from trade, Education policy

JEL Classification: F11, E62

Suggested Citation

Chatterjee, Arpita, Endogenous Comparative Advantage, Gains From Trade and Symmetry-Breaking (November 1, 2013). UNSW Australian School of Business Research Paper No. 2014-18, Available at SSRN: https://ssrn.com/abstract=2418064 or http://dx.doi.org/10.2139/ssrn.2418064

Arpita Chatterjee (Contact Author)

UNSW Australia Business School, School of Economics ( email )

High Street
Sydney, NSW 2052
Australia

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