ADVERSE SELECTION IN LABOR-MARKETS AND INTERNATIONAL-TRADE

This analysis considers trade between countries with labor market distortions due to adverse selection. Comparative advantage is caused either by a better mix of high and low productivity workers, or by the absence of adverse selection in one country. In either case free trade may lead to a loss for the inferior country. A trading equilibrium is Pareto better than an equilibrium in a fully integrated economy with perfect factor mobility if both countries face adverse selection, otherwise the trading equilibrium is Pareto inferior. Subsidies for production of the imported good may improve the social utility of the ''inferior'' country.