Pareto gains from trade: a dynamic counterexample

In a two-period, general equilibrium model with a continuum of heterogeneous agents, we show that Pareto gains from trade can be impossible to achieve if the government uses lump sum redistribution after the trade liberalization and is unable to commit to a particular redistributive policy beforehand. The agents anticipate the intervention and, by underinvesting strategically, counteract the gains from trade. (C) 2004 Published by Elsevier B.V.