Distortions in Two Sector Dynamic Models with Incomplete Specialization

Abstract

We extend the Jones (1971) analysis of the effects of distortions in static 2x2 trade models to the case of a two sector dynamic general equilibrium model of a small open economy with capital accumulation. In contrast to the short run results, the direction of impact of factor market distortions on steady state values do not depend on the value and physical intensity ranking of the sectors. However, the value and physical intensity rankings play an important role in the dynamics in the neighborhood of the steady state.Differences between value and physical intensity rankings of the sectors, which gave rise to paradoxes in the static model, are shown to lead to local indeterminacy or instability in the dynamic model. JEL Classification: F10, F11