This paper discusses the asymptotic behavior of the neoclassical two-sector growth model when the steady-state conditions are not fulfilled, and derives the asymptotic growth rates for cases in which Hicks neutral technical progress occurs in the investment sector, or Harrod neutral technical progress occurs at different rates in the two sectors. The last section compares the asymptotic properties of this model with the standard steady-state properties of the two-sector growth model. IN THE EIGHTEEN YEARS following the publication of Professor Solow's classic one-sector model [8], much work has been done in attempting to explain the stylized facts of growth by means of aggregate models. However, almost without exception, these models have concentrated on analyzing the properties of the steady-state equilibrium, ignoring the behavior of the economy should a steady state fail to exist. Even those models that have implicitly dealt with the singularity of the steady-state solution2 have done so by attempting to explain why the steady state should occur (for example, Kennedy [5] and Chang [4]), rather than by explaining the non-steady-state properties of their models. In this paper we shall study the behavior of a two-sector economy in which the steady-state conditions are not fulfilled. Our analysis will follow, for the most part, the technique developed by Vanek [12 and 13] and extended by Bertrand and Vanek [2]. In these papers the authors study the behavior of the aggregate capitallabor ratio in a one-sector model in which the steady-state condition is not fulfilled. However, they do not explicitly discuss the asymptotic behavior of the economy, nor do they contrast the asymptotic behavior of the non-steady-state economy to those characteristics attributed to the steady-state world. It is the purpose of this paper to examine both of these issues for a two-sector growth model.3

The optimal tariff for a large country equals the reciprocal of the foreign export elasticity of supply. However, if production decisions occur before consumption decisions, the ex ante optimal tariff is not time consistent because the ex post elasticity is less than the ex ante elasticity. We show all countries are worse off if the large country cannot precommit to its ex ante optimal tariff, and that all countries can gain if the large country taxes domestic production of importables.

Edward Ray, in his comment on my 1976 paper, analyzes a slightly different model than the one I presented, and thus reaches different conclusions. His principal conclusions are that: (i) given wage rigidities, a wage subsidy to producers is needed, and this subsidy is equivalent to the optimal static subsidy that ensures full employment in each sector; and (ii) given the forced equilization of wages across sectors, a subsidy to workers is needed to encourage labor transfers between sectors. Thus, Ray finds that full employment is always desirable, whereas I find that some unemployment is (usually) present along the optimum path.

The paper employs the intergenerational model to derive the demands for domestic and foreign currencies from microeconomic optimizing behavior. In the absence of government policy, we obtain the Kareken and Wallace result that exchange rates are constant and indeterminate. We discuss the reasons why nations may find it in their interests to impose probabilistic capital controls. It is shown that the imposition of probabilistic capital controls yields a unique (generally nonstationary) exchange rate path and that this path is determined in accord with the Monetary Approach. As the probability of controls tends to zero, the exchange rate remains determinate.