History Versus Expectations

Abstract

In models with external economies, there are often two or more long-run equilibria. Which equilibrium is chosen? Much of the literature presumes that sets initial conditions that determine the outcome, but an alternative view stresses the role of expectations, i.e., of self-fulfilling prophecy. This paper uses a simple trade model with both external economies and adjustment costs to show how the parameters of the economy determine the relative importance of history and expectations determining equilibrium. In recent years there has been increasing interest economic models which there are positive external economies production; these models have been seen as a way to formulate rigorously a number of heterodox challenges to standard economic doctrine. Ethier [1982a, 1982b] has provided a new, streamlined exposition of Graham's [1927] argument that external economies may make the pattern of international trade arbitrary and the gains from trade ambiguous, and has also shown that monopolistic competition intermediate goods may lead to de facto external economies production of final goods. Romer [1986a, 1986b] has shown that external economies may remove the traditional distinction between factor accumulation and technical change as sources of growth, and has also shown that an Ethier-like formulation can rationalize Young's [1928] vision of cumulative growth driven by increasing returns. Murphy, Shleifer, and Vishny [1989] have shown how market-size effects can effect create external economies among firms investing industrialization, and have used this insight to offer a rigorous formulation of Rosenstein-Rodan's [1943] Big Push theory of economic development. In my own work [1981, 1987] I have used external economies to formulate an ''uneven development model which the division of the world into rich and poor nations takes place endogenously, and a model which a variety of heterodox views are justified by a framework which patterns of specialization generated by historical accident get locked in through learning effects. A key element many of these models is the possibility of meaningful multiple equilibria the presence of external economies. The point is obvious: when there are external economies, it will often happen that the return to committing resources to some activity is higher, the greater the resources committed. Thus, c 1991 by the President and Fellows of Harvard College and the Massachusetts Institute of