ENDOGENOUS TRADE UNCERTAINTY - WHY COUNTRIES MAY SPECIALIZE AGAINST COMPARATIVE ADVANTAGE

Using an approach where the probability of trade is a function of the volume of trade, we show that uncertainty in international trade may force a small economy to specialize in the production of the good in which it has a comparative disadvantage. This reversal in the pattern of incomplete specialization in production is not reflected in the trade pattern. The first-best policy response in the presence of endogenous uncertainty is not the imposition of tariffs or subsidies but a reduction of trade uncertainty itself, possibly through clear commitment to free trade or GATT rules and procedures.