Adjustment Costs and Gradual Trade Liberalization¤ by

This paper analyzes dynamic bilateral trade liberalization between two large coun-tries. Trade liberalization causes the importable sector of each country to shrink and thereby causes reallocation of labor between sectors. Assuming that each moving worker must pay a ¯xed adjustment cost, a country has to bear a total adjustment cost which is linear in the amount of moving workers. We derive the most-cooperative, self-enforcing trade liberalization path, and ¯nd that in general trade liberalization is gradual. We also ¯nd that trade adjustment assistance that compensates workers for relocation out of the protected sector will accelerate the pace of trade liberalization