A Ricardian Model with Endogenous Comparative Advantage and Endogenous Trade Policy Regimes*

Wenli Cheng
New Zealand Treasury

Meng-chun Liu
Department of Economics, Monash University

Xiaokai Yang
Department of Economics of Monash University and
Harvard Center for International Development
Email xiaokai_yang@ksg.harvard.edu

November 1998
JEL classification code: F10, H20
Suggested running head: Ricardo model with endogenous comparative advantage

* We are grateful for financial support from Australian Research Council and for comments from two referees. The remaining errors are ours.

Abstract:
This paper develops a model with transaction costs and endogenous and exogenous comparative advantages to show that the level of division of labor and trade increases as transaction conditions improve. It identifies the conditions for trade negotiations that result in zero tariff rates and for the coexistence of unilateral tariff protection and unilateral laissez faire policies. The model may explain the policy transformation of some European governments from Mercantilism to laissez faire in the 18th and 19th century and policy changes in developing countries from protection tariff to trade liberalisation and tariff negotiation.

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