INTERNATIONAL RESOURCE ALLOCATION: The Basic Model 2


Two features of this matching technology should be noted at the outset. First, in order to achieve maximum output it is necessary that all matches that are concluded be formed between producers on opposite sides of zero, so that the sum of all producers’ distances from zero is contributed to production. It will thus be convenient, when we analyze matching with incomplete information in section IV, to call matches between producers on opposite sides of zero “good matches” and matches between producers on the same side of zero “bad matches.” Second, producers differ in their average desirability as match partners, with producers farther from zero tending to be more desirable. This will be especially important when we introduce group ties in sections V and VI, because it will allow group members to differ in their decisions whether to use their ties when matching internationally.
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Each producer has the option of matching with a domestic partner, or of entering the international market. In the domestic market there is complete information: everybody knows all others’ types and everybody can approach any prospective partner. In equilibrium, competition for desirable partners determines the share of output that goes to each member of the match. All domestic partnerships employ domestic labor.

Alternatively, a producer can enter the international market, where he will match with a foreign producer, similarly interested in an international partnership, and where the two partners can choose which of the two countries’ labor to employ. Entry to the international market is costless–we want to abstract from traditional trade barriers such as taxes and transport costs in order to isolate the effects of informational barriers. In the international market, information is incomplete: until the match is established and information exchanged, a foreign producer can be of any type with equal probability. Once a partnership is formed and information about types is revealed, each partner has the option of returning to his home market. Thus only matches yielding profits equal at least to the sum of what the two producers can obtain at home will be concluded, and we assume that any net surplus is then divided equally. In other words, total profits are shared between the two partners according to the Nash bargaining solution, where domestic profits constitute the threat points. Because the option of returning home at no cost is always available, we study equilibria where all producers attempt the international market.

The timing of the model is the following. First, producers go to the international market where partnerships are formed; then information about one’s partner is revealed, successful matches are confirmed and unsuccessful ones are broken; finally producers who have rejected their international matches return home and establish new partnerships. The labor markets clear when all demands for labor, from domestic and international ventures, are received. In the resulting equlibrium, international trade consists of flows of producer (“managerial”) services in exchange for flows of output.