Long‐run Lunacy, Short‐run Sanity: a Simple Model of Trade with Labor Market Turnover*

Abstract

AbstractIt is often argued that international trade is all about long‐run relationships. In this paper, we argue that this view is flawed when factor markets are characterized by turnover. Toward that end, we provide a simple dynamic model of trade with labor market turnover and show that the relationship between the economy's short‐run and long‐run behavior is more complex than in traditional trade models. For example, in the short run, the economy may produce outside of its long‐run frontier. We show that focusing on long‐run relationships can lead one to draw faulty policy conclusions, while focusing on its short‐run behavior restores sanity. The implication is that in the presence of factor market turnover, international trade issues can only be understood by studying the entire dynamic path of the economy. Long‐run relationships should be ignored.