The authors characterize the equilibrium for a small economy in a dynamic Heckscher-Ohlin model with uncertainty. They show that, when trade is balanced period-by-period, the per capita output and consumption of a small open economy converge to an invariant distribution that is independent of the initial wealth. Further, at the invariant distribution, with probability one there are some periods in which the small economy diversifies. These results are in sharp contrast with those of deterministic dynamic Heckscher-Ohlin models, in which permanent specialization and non-convergence occur. One key feature of the authors' model is the presence of market incompleteness as a result of the period-by-period trade balance. The importance of market incompleteness, and not just uncertainty, in achieving the authors' results is illustrated through an analytical example. Further, numerical simulations show that the convergence occurs more quickly as the magnitude of the shocks increases. Thus, the results extend the predictions of income convergence, standard in one-sector neoclassical growth models, to the dynamic multicountry Heckscher-Ohlin environment.

Also published as:

A Stochastic Dynamic Model of Trade and Growth: Convergence and Diversification
Journal of Economic Dynamics and Control (0165-1889)
March 2012. Vol. 36, Iss. 3, pp. 416-32