Endogenous Inequality in a Trade Model with Private Information

Abstract

We develop a general equilibrium model of trade between identical countries. The model is similar to a 2x2x2 Heckser-Ohlin model, but the factors of production, skilled and unskilled labor, are endogenously determined from human capital investments by the workers. Firms are only able to observe human capital investments with noise, which creates an informational externality. Due to interaction between the informational externality and general equilibrium effects, equilibria arise where countries specialize as rich, high-tech, countries and poor, low-tech, countries respectively, also when there is a unique autharky equilibrium. Protectionism may make the poor country better off, but we can construct examples where the efficiency gains are large enough to make the specialization equilibrium better than the unique autharky equilibrium also for the poor country.

Keywords: International trade, private information, inequality, specialization, human capital, informational externality

JEL Classification: D58, D62, D82, J41, J71