Working Paper: CEPR ID: DP10625
Authors: Peter Debaere; Toni Glaser; Gerald Willmann
Abstract: We develop a two-sector, two-factor general equilibrium model of international trade with imperfect short-term mobility of one factor that features uncertainty about sectoral productivity, and hence uncertainty about the terms of trade. Uncertainty resolves after the sectoral capital allocation has been decided. We show that the capital allocation chosen by producers need not be welfare maximizing if producers and consumers have differing attitudes to risk. In a small country facing uncertain terms of trade, risk-neutral producers specialize more in exporting than is preferred by risk-averse consumers. From a national welfare perspective this misallocation can justify the use of trade policy that deviates from free trade. In the general case with uncertainty in both countries, there exists a trade-of between trade as insurance against domestic shocks, and protection as insurance against foreign shocks. In our framework, the optimal trade policy of a country is thus very much a function of its particular circumstance: the nature of its comparative advantage and especially the size and correlation of domestic vs. international shocks that a country faces. The model we propose can explain the persistent protectionism especially in sectors such as agriculture.
Keywords: Trade policy under uncertainty; Delayed structural adjustment
JEL Codes: F13; F62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk-averse consumers prefer a more diversified production pattern (D11) | misallocation of resources under free trade (F16) |
| misallocation of capital (E22) | greater exposure to terms of trade volatility (F14) |
| optimal trade policy is influenced by size and correlation of domestic and foreign shocks (F10) | countries may prefer protectionist policies (F52) |
| trade policy can serve as a mechanism to balance risks faced by consumers and producers (F13) | complex interaction between comparative advantage and risk management strategies (F12) |