Knowledge that Transforms

The link between international factor mobility and commodity trade has received some attention in recent years. In the main, this analysis has served to extend and tighten Robert Mundell's original demonstration of the basic substitutability between goods and factor movements in the standard trade model,' and to expand the discussion to examine the interaction between commodity and factor taxation.2 In the absence of impediments to factor movements (physical restrictions or differential taxation on foreign and domestic earnings), any import tariff is prohibitive, in the sense that the factor flows it induces will eliminate international commodity exchange.3 Unless both commodity and factor taxation are possible, it appears a country has little influence over the composition of its trade or domestic production. When factors are immobile, the optimal policy to achieve some desired production level other than the free trade level is to use the appropriate production tax-subsidy scheme. With factor mobility, however, this runs into the same problems as the tariff and would eventually force the country to specialize in the protected industry. But tariffs (or price restrictions) represent but one major form of commercial policy. Previous analysis has neglected the other-quantitative restrictions. The object of this note then is two-fold. First to demonstrate that quantitative restrictions on commodity trade will permit a country to influence its trade and production patterns, despite factor mobility, and without requiring distortions in both factor and commodity markets. Second, while doing this, to demonstrate the basic differences in the adjustment processes under these two commercial policy regimes. Although, in a static framework they are essentially equivalent, once factor mobility is introduced the distinction between a price and a quantity restriction becomes important. This last result is quite general and readily extends beyond the confines of the structure examined here. I begin by briefly considering the effects of an import tariff on trade and production in this system, and then go on to compare this with the effects of an import quota. Suppose the world is composed of two countries (home and foreign), each of which produces two goods (the home exportable Xe and the home importable Xm), through the services of two factors of production (labor and capital). Assuming identical linear homogeneous technologies in each country, let the factor endowments be such that the initial free trade equilibrium implies factor price equalization. Thus, although capital is assumed internationally mobile, there exists no incentive in the form of a return differential for it to move. There are two aspects of this equilibrium which are important for future results: First, the allocation of capital between the two countries which would give this equilibrium is not unique.4 Second, within a certain range,5 shifting capital from * Assistant professor of economics, Virginia Polytechnic Institute and State University. I am indebted to Rudiger Dornbusch, Michael Mussa, and a referee for comments and sii(Testionsn 1 See Mundell and, for example, Frank Flatters, Douglas Purvis, and Melvyn Krauss. Certain ambiguities can arise if both factors are internationally mobile, however. First, determining what it is that defines a country (usually its endowment), and second, if tastes are different in the two countries, determining who it is that holds these tastes. 2 See Ernest Nadel. Particularly when the assumption of identical technologies is relaxed-see Ronald Jones and John Chipman. 3 A one-way commodity flow will still occur, however, if foreign earnings are repatriated. Alternatively, the import restriction could force specialization in production of the importable. 4There is a range of endowment allocations for which the same total world production, relative prices and factor returns could occur. See Robert Warne. 5 Depending on how close each is to specialization initially. Again see Warne.

Stephen Goldfeld's conclusions that analysis of my article is flawed by a statistical confusion and that the extra equation is a red herring pure and simple are based on a set of assumptions which are virtually opposite of ones I worked with, and depend on an excessively restrictive interpretation of what is implied by use of Theil certainty equivalence framework. Under assumptions stated in my article, my conclusions remain valid. It is Goldfeld's new assumptions that create errors he then discovers in my paper. The policy problem that I modelled was one in which state had relatively firm policy targets and adjusted its policy instruments in response to shifts in expected of uncontrolled variables. In order to emphasize potential problem, I assumed that X* and Y* were constant, so that X was chosen to minimize equation (1), quadratic loss function, as S, expected value of S, shifted from to period.' As I stated in article, clearly changes every period (p. 1027). But I used symbol S to denote policy maker's certainty-equivalent forecast of S, i.e., Goldfeld's S. My policy examples all contained same assumptions. Instrument movements would ... counterbalance other forces tending to move goal variables away from their desired values (p. 1029) represents a typical sample from my discussion. Following Theil, I assumed that policy maker behaved as if S, expected value of his subjective probability distribution (or forecast distribution) of S, was known with certainty, but not that forecast distribution or S never shifted or changed over time.2 Goldfeld reverses these assumptions to describe and analyze a fickle policy maker in a world of constant expected of uncontrolled variables, very opposite of my assumptions and a relatively uninteresting case at that. He argues that natural presumption is X* and Y* vary nonrandomlv over sample and, simplicit , that S is constant over sample. Only for case where S is constant is Goldfeld's conclusion in footnote 5 that constancy of X* and Y* implies constancy of policy instruments X correct. In footnote 4 Goldfeld suggests that assumption that S is constant is convenience only, but with respect to problem addressed in my article, this is not so. To see this, define Et=St-st.3 Here e is a random variable with an expected value of zero and constant variance, and true reduced form is y=rx+-+E. Under Gold-

In a general equilibrium model with uncertain second period demand, incomplete markets, and costly labor mobility, the authors analyze the feasibility and optimality of alternative employment contracts. For the case where layoffs are prohibited, they demonstrate that both the fixed wage--constant employment contract, as well as the flexible wage--variable employment contract are equilibria in firm behavior, while the latter is preferable from society's point of view. In the case with layoffs, they show that the competitive mechanism leads to a less than optimal number of layoffs, and demonstrate that unemployment insurance with less than complete experience rating lowers the cost of layoffs to the firm and encourages labor mobility. In the context of the model, a properly designed unemployment insurance program yields a fully efficient allocation.