Differential Population Dynamics and Trade between Large and Small Countries

This paper investigates the implications of the addition of differential population dynamics to a simple 2x2x2 model of international trade within an overlapping-generations (OLG) framework, by assuming that one of the trading partners has the power to set the terms of trade (i.e., is large) at the beginning. The two countries considered are assumed to be identical in every respect except for demographic characteristics. The effects of these demographic differences are explored by comparing autarky and trade and unequal population dynamics are shown to affect the relative abundance of the factors of production in each region, leading to differences in wage rates and rentals for capital under autarky conditions. The resulting differences in autarky relative prices create the grounds for trade in the same sense as the static Heckscher-Ohlin model. Our results reveal that unlike previously reported results from OLG studies on dynamic trade equilibrium, steady state welfare losses to the region with low population growth can be avoided in the set-up we consider.