INTERNATIONAL-TRADE AND INVESTMENT UNDER DIFFERENT RATES OF TIME PREFERENCE

This paper attempts to integrate the theory of trade with that of capi tal movements and to study the two-country world where each nation has a different rate of time preference. It resolves the indeterminacy pr oblem intrinsic in the Heckscher-Ohlin model where trade and factor mo vements coexist by assuming that capital movements are infinitesimally more costly than trade in goods. Under certain assumptions, one can d ichotomize the behavior of asset accumulation from the dynamic pattern of trade specialization. Complete specialization will most likely tak e place in the country with the higher rate of time preference, which specializes in the more labor-intensive sector. It is shown that a sin gle-commodity model does exaggerate the amount of capital movements, b ut that the qualitative nature of asset accumulation patterns obtained in a single-commodity model of capital movements stays intact in the model that incorporates trade. This paper offers another explanation o f the Feldstein-Horioka paradox that domestic investment responds more closely to increasing savings than capital outflows do. If an economy is imperfectly specialized, increased savings will be absorbed in cap ital deepening rather than in capital outflow. (C) 1994 Academic Press , Inc.