Multiple equilibria, coordination, and transitional growth

We study a small open economy with two sectors and two factors of productio n, in one of the sectors, external economies of scale are generated through the industry-level capital input. This leads to a divergence between priva te and social production possibility frontiers as well as to multiple equil ibria. The equilibrium selection problem that arises is solved by agents wh o follow a simple trial-and-error learning rule. The growth path of the eco nomy as agents learn lies below the production possibility frontier and may display cyclical transitional dynamics. We also show that coordination pro blems which may prevent the economy from attaining the "good" equilibrium m ay be alleviated by the temporary use of policy instruments that shape the allocation of resources. (C) 1999 Elsevier Science B.V. All rights reserved .