Optimal Domestic Regulation and the Pattern of Trade∗

Abstract: This paper analyzes the impact of asymmetric information within countries on the pattern of international trade. We append to the standard 2 × 2 Heckscher-Ohlin model of a small economy a continuum of sectors producing intermediate non-tradable goods. Those goods are produced by monopolies having private information on their technologies. With asymmetric information and under optimal regulation, production in these sectors is inefficiently low. The small open country is relatively richer in the factor which is more intensively used by the privately informed sectors. Asymmetric information can reverse the country’s pattern of comparative advantages. Due to the existence of information rents in these sectors, the economy receives also not only the standard factor endowments (capital and labor) but also an “informational endowment” which boosts demand for tradable goods. Free trade is Pareto is dominated by autarky when, under asymmetric information, there is a reversal of comparative advantages. ∗The usual disclaimer applies