RISK-SHARING, ADJUSTMENT, AND TRADE

We consider a dynamic model of labor mobility in a small open economy with stochastic terms of trade. Migration is costly and markets for labor income risk are absent. Risk-aversion slows down the movement of the most productive workers into the risky sector, and speeds up that of the least productive ones. The effect of tariffs and autarky on risk-bearing is examined. A given policy may improve social welfare for some initial conditions and lower it for others. Thus policy design for such an economy is context-specific and can be time-inconsistent.