Specialization and Welfare in the Presence of Imperfectly Integrated Capital Markets and Learning-by-doing
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We study a two-sector, two-period model with learning externalities in the modern sector and imperfectly integrated capital markets. We find that higher capital market integration lowers the requirements on the learning pattern necessary for free trade to lead to an equilibrium with maximal specialization in modern sector activities. We further find that the equilibrium with maximal specialization in modern sector activities Pareto dominates, if it exists, any other free trade equilibrium, and that autarky can Pareto dominate free trade if capital markets are poorly integrated, even when there is maximal specialization in modern sector activities under free trade.
KeywordsCapital market integration Learning-by-doing Trade patterns Gains from trade
JEL ClassificationF36 F12 F15 G15 O16
I would like to thank Nils Herger, workshop participants at Monash University and the University of Otago, and a referee for helpful comments. Financial support of the Ecoscientia and the Swiss National Science Foundation is gratefully acknowledged.
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