A GENERAL EQUILIBRIUM MODEL OF EXPORT EARNINGS INSTABILITY IN DEVELOPING ECONOMIES

Abstract

BEGINNING with the seminal paper by Sandmo (1971) and the later elaborations by Batra and Ullah (1974), there is now a vast literature on the economic consequences of price (or production) uncertainty on the theory of the firm. While the theoretical apparatus of this body of work has found its way into many diverse areas of economic research, its most natural and straightforward application has been in the theory of international trade (see, for example, Batra (1974) and Anderson and Riley (1976)). However, though the literature on this latter subject has itself grown voluminous, almost all the studies involved were concerned with the examination of how the traditional trade theory propositions, such as the Ricardian theory of comparative advantage, the Heckscher-Ohlin theorem, and gains from trade, etc., would be affected when the terms of trade, or the productive technology, which a country faces is uncertain. Little attention is paid to the macroeconomic implications of fluctuating prices and output, particularly for those developing economies that are most susceptible to these types of disturbances. To be sure, there is an older body of related literature on the welfare effects from price stabilization (see the survey by Turnovsky (1978)), most of which are partial equilibrium studies. Recently, Newbery and Stiglitz (1981) have provided a more general treatment of the theory of commodity price stabilization, couching their analysis within the framework of economic behavior under risk. However, like the earlier works, no attempt is made in their study to provide for a unified general equilibrium framework in an open-economy setting in which macroeconomic considerations of price stabilization in developing economies can be systematically analyzed. The present paper is an attempt in this direction. It has as its precursors the works of Dixit (1978) and Neary (1980), but goes beyond them' by (a) incorporating uncertainty, both in prices and production, into the framework of analysis in the context of a general equilibrium trade model, and (b) modeling the import-export structure which is of particular relevance to