International Trade and Domestic Distortions: Modelling the Transition Process

According to the standard view, when full competition prevails in product, labour, and capital markets, positive or negative exter- nal trade shocks may be accommodated by the migration of jobs be- tween sectors; the negative impact on some households’ income of lower nominal wages will be more than o¤set by lower prices of im- ported nal goods. Unemployment, if any, will be temporary, unless labour market rigidities prevent the necessary adjustment. We ar- gue that trade shocks trigger a process of creative destruction that necessarily causes distortions in the structure of productive capacity and hence market disequilibria. Therefore, the structural change that follows trade shocks can no longer be analysed within an equilibrium framework. The transition following a shock may be characterized by increasing imbalances, and create scope for policy intervention. The model presented in this paper, which focuses on the time dimension of production and market imbalances, allows clarifying the debat