Protecting Losers: Optimal Diversification, Insurance, and Trade Policy

50 Pages Posted: 10 Jul 2007 Last revised: 19 Jan 2009

See all articles by S. Lael Brainard

S. Lael Brainard

Deputy National Economic Advisor, The White House; National Bureau of Economic Research (NBER)

Date Written: July 1991

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

Brainard, S. Lael, Protecting Losers: Optimal Diversification, Insurance, and Trade Policy (July 1991). NBER Working Paper No. w3773. Available at SSRN: https://ssrn.com/abstract=473939

S. Lael Brainard (Contact Author)

Deputy National Economic Advisor, The White House ( email )

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