Intersectoral adjustment and unemployment in a two-country Ricardian model

Abstract

In a two-country Ricardian model, we study the dynamics of intersectoral reallocation of labour following upon a once and for all move to free trade. The job creation/destruction process in both sectors is slow and this results in unemployment during the transition toward the long run free trade equilibrium. We identify different free trade regimes depending on whether or not the world relative price is between the two autarkic prices. In some regimes, one of the two countries overshoots its autarkic equilibrium i.e. temporarily specializes according to its comparative disadvantage. In that case, welfare increases in both countries. In other regimes, the adjustment process is monotonic in both countries but welfare increases in only one country. When the two countries have “very” different rates of job creation/ destruction, the world price adjusts in such a way that the difference in adjustment speed between the two countries decreases.